As she prepares for her second Budget next week, Rachel Reeves should be mindful of the ‘first law of holes’.
It was formulated by one of her predecessors, Denis Healey, who had the unenviable distinction of having to ask the International Monetary Fund for a bailout for Britain in 1976.
The law of holes states that when you find yourself in one, stop digging. And remember that when you do stop digging, you are still in a hole.
Healey’s anecdote is cited in a chapter written by bond market expert Moyeen Islam in the Institute for Fiscal Studies Green Budget report.
Will Reeves stop digging? Not a chance.
Friday’s turbulence in the bond market – investors sold off gilts, or UK government IOUs, which has the effect of increasing the cost of borrowing – is an ominous signal. It came in response to reports Reeves may not, as widely touted, break her promises to raise income tax rates. In itself, that might be a good thing: the problem, from the bond market point of view, is the chaotic, reactive policymaking, the weather-vane changes of direction and the seeming lack of competence and control.
Time to stop digging: Rachel Reeves is in a hole but reluctant to throw away her trusty spade
There are concerns about Reeves’ and Starmer’s unwillingness to take unpopular decisions in order to repair the fiscal black hole, not just on taxes but also putting curbs on welfare spending.
There is a credibility crisis. Farcical briefings against Health Secretary Wes Streeting have created instability and undermined confidence, on top of the endless speculation Reeves has allowed to foment about her tax measures. In itself, this atmosphere erodes credibility and has a chilling effect on growth. The latest rumours include talk of lowering income tax thresholds, which are already frozen, so people pay higher rates on lower incomes.
This is just a slightly less obvious way of picking the nation’s pockets. It still sends out a message that striving and saving will be punished. It’s a dangerous signal to convey when more than nine million are economically inactive, many of them squandering their own potential and draining the welfare system.
It isn’t heartless to say so. For a country to support its people when they have a genuine need, it needs the wherewithal. Failing to tackle the black hole, borrowing more and spending more will ultimately make poorer Britons even worse off. Cuts in welfare spending, Moyeen Islam says, are ‘totemic’ for bond markets, as much for showing the direction of travel as for the sums of money involved.
It is a minor miracle, in my view, that Reeves has not experienced more of a kickback from bond markets before now. This seems to be because the alternative to her might be even worse.
The broader backdrop is not helpful. There are underlying factors that are likely to constrain demand from buyers and could therefore put up borrowing costs, including the Bank of England’s unwinding of Quantitative Easing and reduced demand for gilts from final salary pension schemes.
Some in the Labour party, such as Mayor of Greater Manchester Andy Burnham, the self-styled King of the North, think the UK should not be ‘in hock’ to markets. Has he heard of Liz Truss?
The UK is paying more than £100billion a year in debt interest. If Reeves does not maintain credibility with the bond market, we will be further on the road to ruin.
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