Closing post
Time to recap
The pound has weakened, and UK government bonds have strengthened, after chancellor Rachel Reeves appeared to clear the way for tax rises in this month’s budget.
In an early morning speech, Reeves declined to reiterate Labour’s manifesto commitment against broad-based tax hikes, warning that the public finances were in a worse state than expected after “years of economic mismanagement”.
Reeves told reporters her Budget priorities were to bring down borrowing costs, NHS waiting lists and the cost of living, while also citing predictions that weak UK productivity would create a large fiscal black hole.
Reeves explained:
“As chancellor, I have to face the world as it is, not the world that I want it to be. And when challenges come our way, the only question is how to respond to them, not whether to respond, or not.”
Reeves also stated her ‘iron clad’ commitment to her fiscal rules.
The City took the speech as a clear signal that taxes will rise on 26 November.
Gilt prices rose, pushing down the yield (or interest rate) on UK debt. Currently, the yield on UK 10-year bonds is down 3 basis points (0.03 percentage points) at 4.4%, while long-dated 30-year bonds are also down 3bps at 5.18%.
Some economists predicted that a tough budget packed with fiscal tightening measures could encourage the Bank of England to cut interest rates more quickly. In response, the pound has dropped by almost a cent today to $1.3044, a near-seven-month low.
Rachel Reeves could create a “virtuous feedback loop” by raising taxes to bring down public borrowing, and prompting lower interest rates, argues Andrew Wishart, economist at Berenberg bank.
In an upbeat take on this morning’s speech, Wishart writes:
UK Chancellor Rachel Reeves’ commitment to inflation and public debt reduction at the expense of the Labour party’s manifesto commitment to not raise certain taxes in an unusual pre-budget speech this morning is encouraging.
A major tightening of fiscal policy at the budget announcement on 26 November could create a virtuous feedback loop to lower interest rates and public borrowing, even if it is delivered by tax hikes rather than spending cuts.
By making “cutting the national debt” one of the guiding principles of the budget, the Chancellor hinted that she would tighten fiscal policy more aggressively than markets anticipated so far. Existing plans to run a current budget surplus of £9.9bn in fiscal year 2029-30 would only have stabilised the debt-to-GDP ratio. Reeves confirmed that her totemic government investment plan totalling 2% of GDP per year will remain in place, leaving her the options of cutting day-to-day spending or raising taxes. Although the Chancellor mentioned welfare reform and public sector productivity, the prioritisation of health and defence spending suggests that spending cuts will make a marginal contribution to the tightening of fiscal policy in the 26 November budget at best.
The Chancellor as good as abandoned the Labour party’s manifesto commitment not to raise any of the main taxes on income and consumption (income tax, value added tax and national insurance) by avoiding restating it. This paves the way for a broad-based tax hike at the budget.
