Investors around the world are continuing to sell government bonds, which means that borrowing – for the government, for employers and for consumers – is getting more expensive. The lower the price of debt in the market, the more it costs the issuer of that debt to borrow. In a deliberate confusion of correlation and causation, some British news organizations and politicians have chosen to attribute the increase in UK breast yields entirely to what Kemi Badenoch has come to call a “Burnham premium”. This suggests that either Kemi Badenoch does not understand the forces that removed her party from government, or she is happy to misrepresent them to her voters. Maybe a bit of both.
What IS the truth is that the market is extracting higher yields (debt servicing costs or interest) from UK debt than from other developed economies. This is despite the fact that Britain’s debts are a relatively normal 94 per cent of our GDP. The debt of fiscal basket cases like France (116 percent), America (123 percent) and even Italy (137 per cent) has higher prices (and therefore lower yields) than UK bonds.
Fortunately, there are some steps a future prime minister can take to address this situation. Unfortunately, they may not be extremely popular.
Reevesthe gambit
Since July 2024, Rachel Reeves has not ordered a coffee without reaffirming that the implied expenses would be within her fiscal rules. A positive signal for the bond market would be to maintain Reeves’s position, either in person, literally keeping Reeves as Chancellor, or in spirit, publicly stating – as often as possible – that you also consider these rules immovable. However, rules are only half the picture: you also need reliability.
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Beat the laggards
It is not reasonable to argue that there is a significant “Burnham premium” in UK bond yields because the market does not have enough information on Burnham’s policies to price them. However, there could be a Starmer premium because the market knows the current prime minister has been unable to impose cost-cutting policies such as scrapping the winter fuel allowance or reforming the benefits system. If you cannot impose fiscal consolidation with more than 400 MPs, then in terms of the market you may not have a majority. A new prime minister who was better at selling policies to the rebels – or more ruthless in imposing their plans – could increase the credibility of the government’s plans in the market.
Just raise the tax (otherwise)
In very general terms, the market tends to “prefer” (yes, it doesn’t prefer anything, it’s a huge set of ever-changing investment decisions, but let’s anthropomorphize it or we’ll be here all day) lower spending over higher taxes. The fiscal impact of spending cuts is more obvious (people can change their behavior to avoid taxes, they can’t make the government spend more money) and the cuts can also lower inflation (which makes bonds less valuable to investors), at least in the short term. However, in the long run, you need to invest if you want economic growth. If you want to do fiscal consolidation without reducing public spending, raising taxes is the next lever you can pull. Not by tweaking a tiny bit of tax to make things fit the OBR’s forecast: big, bold reform of a dysfunctional tax system it would solve many issues. One possible drawback is that not addressing the dysfunctional tax system was a core element of Labour’s 2024 manifesto. Perhaps it would be easier to…
Rejoin the EU and sign up to the Euro
The reason why Italy has lower bond yields than us is that it is part of the EU and the Euro. EU membership produces more free trade, which means cheaper goods (we import half of our food from the EU) and therefore less inflation. It also means splitting a central bank – the European Central Bank, or ECB – which keeps key rates lower than the Bank of England and does more to protect bond prices (the BoE has been accused of going the other way, selling more bonds back into the market). The European debt market is much larger than the UK’s – secondary market trading volumes are around three times larger – and that means there is more demand. We would pay less for our debt as Europeans.
There may be some voters who would find EU reunification and adoption of the euro controversial; what’s an extra £50,000 on the mortgage when you can use coins with a picture of the King on them?
The end of the war in Iran
The real reason government bonds are selling off around the world is the fact that the US and Israel have started a war against Iran, which has disrupted shipping in the world’s most important energy corridor (the Strait of Hormuz). Investors expect more inflation as a result of the energy price hike it has caused, which erodes the value of bonds. Another measure that would lower bond yields would be to simply end the war in Iran, and ideally Russia’s war against Ukraine. Or failing…
Milli-Burnham conjecture
Another reason the UK is being charged more for its debt is that the ‘pass-through’ from energy prices to inflation is higher in the UK than in other countries. The same increase in the wholesale price of gas will produce more inflation in Britain than in other European countries. We are very dependent on gas for home heating and extremely dependent on cars for transportation. Despite living in the North Atlantic, we have some of the worst insulated housing stock on the continent. We have extremely high industrial energy costs. There is some oil left in the North Sea, and using it is just as green (if not more so) than using oil from anywhere else, which we will obviously continue to do. But the only way to reduce the UK’s chronic inflation problem in the long term is to produce more energy and use less energy, because the price of energy is the price of everything else.
Again, this has a political cost, because there are people who prefer sheep farms to solar farms, or who think isolation is smart. But look at the way gilt yields rose in 2022: the rise in yields actually started well before Truss’s “mini-budget”, when she announced her other major policy, the Energy Price Guarantee, which linked government borrowing to the energy market. This is it a reading of Andy Burnham’s famous commentary New statesman about being “in trouble” with bond markets: the UK has a debt premium because, after a very long period of low investment, we don’t have enough control over our spending.
(Further reading: Wes Streeting reopens the Brexit box)
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