A major plank of Sir Keir Starmer‘s pitch at the election was that Labour would bring much-needed stability to the UK economy.
But those promises now have a distinctly hollow ring as the Government grapples with a bruising market backlash.
Traders have been heaping risk premium on the state’s borrowing, with yields on gilts at the highest levels in decades. Meanwhile the pound has been dropping against the US dollar and the euro, leading one City analyst to jokingly name it the ‘Great British Peso’.
Chancellor Rachel Reeves is looking down the barrel of trimming her spending plans or imposing yet more tax hikes in the coming months.
So what has gone wrong with the economy, and how bad could things get?
A major plank of Sir Keir’s pitch at the election was that Labour would bring much-needed stability to the UK economy
Donald Trump’s threat to impose ‘beautiful’ tariffs have sparked alarm about the potential for another inflation surge and lower growth
Traders have been heaping risk premium on the state’s borrowing, with yields on gilts at the highest levels in decades (chart shows 10-year gilts rate)
Is it the global economy, stupid?
There is no doubt that government bonds have been taking a pasting around the world.
Donald Trump’s threat to impose ‘beautiful’ tariffs sparked alarm about the potential for another inflation surge and lower growth.
Concerns were raised about ‘sticky’ prices in the US and the prospect of an extra $6trillion of debt, meaning interest rates on US Treasury bonds spiked.
However, the UK seems to have been harder hit than many other countries.
The yield on 10-year gilts – the way the government raises money – has topped 4.8 per cent for the first time since the financial crisis of 2008.
Interest on 30-year gilts has risen from around 4.35 per cent in September to reach a 27-year high of 5.38 per cent.
At the same time the pound has seen significant falls against both the US dollar and, to a lesser extent, the euro – an unusual combination because higher interest rates on bonds tend to bolster the currency.
A Bloomberg metric also suggests that, although the Government is still comfortably able to raise the money it needs, liquidity has been worse in the UK bond markets than elsewhere. That could be a sign that investors are staying away.
Critics argue that the government’s moves so far have actually crushed economic activity
So why are things looking worse in Britain?
There has been a sense for some years that financial markets are sceptical of Britain’s prospects.
Sterling plummeted against the dollar after the 2008 credit crunch and has never fully recovered – seeing another sharp decline around the time of the Brexit vote in 2016.
The currency has clawed back some ground after reaching a historic low of just $1.13 in the wake of Liz Truss’s mini-Budget in 2022.
This is partly a story of US strength, as the tech revolution has been dominated by American firms.
But UK stocks are often regarded as undervalued and London has been viewed as struggling to attract new listings.
Meanwhile, Britain has continued to rack up big debts – driven by wider demographic factors and a series of crises such as Covid and the Ukraine war – while successive governments have been unable to improve productivity, cut benefits and get growth motoring.
The eye-watering inflation seen worldwide in recent years, with energy prices a particular problem, also exposed deep-seated problems in the UK and obliged the Bank of England to push interest rates to a 15-year high.
Britain has continued to rack up big debts – driven by wider demographic factors and a series of crises such as Covid and the Ukraine war – while successive governments have been unable to improve productivity, cut benefits and get growth motoring
Wasn’t this long-term decline what Labour was promising to tackle?
Sir Keir and Rachel Reeves have made boosting growth their top priority, including using Labour’s huge majority to force through difficult changes such as planning system reform.
But critics argue that the Government’s moves so far have actually crushed activity.
The October Budget imposed £41billion of tax rises – the biggest hike ever recorded at a single fiscal event, according to the Office for Budget Responsibility watchdog – mainly targeted on employer national insurance.
Ms Reeves insisted it was needed to fill a £22billion ‘black hole’ left by the Tories, but much of it went on a series of bumper public sector pay deals, such as for NHS staff and train drivers.
Businesses are now warning they will be forced to increase prices, putting upwards pressure on inflation, and cut back on jobs.
The Chancellor also rewrote debt rules to borrow around £70billion a year more, saying it will be invested in improving infrastructure to drive growth.
However, the markets have become increasingly sceptical about the effectiveness of Labour’s strategy as evidence has emerged of a slowdown and stubborn inflation – known as ‘Stagflation’.
Ms Reeves’s spending plans were already regarded by experts as implausibly tight – and they have now been thrown into disarray by extra debt servicing costs.
Doesn’t sound great, but just how grim could it get?
The rise in gilts yields has been slower than the Truss meltdown, but levels are now higher.
Some analysts have even warned that the UK is at risk of a 1976-style disaster, when Denis Healey was forced to get a bailout from the International Monetary Fund after a Sterling crisis.
Others argue the situation is rather different now, with interest rates nowhere near as high.
If gilts yields stabilise where they are, the Institute for Fiscal Studies think-tank has estimated Ms Reeves will need to find another £8billion a year to cover extra servicing costs.
That would be enough to wipe out her spending ‘headroom’ but not huge in the wider scheme of Government budgets.
A key moment could come next week when the latest figures for headline consumer price index inflation are released.
If that shows prices rising above expectations then concerns about the UK’s outlook could deepen.
It would deal a big blow to hopes that the Bank of England will cut interest rates quickly to breathe life into the economy.
Ministers will also be braced for Trump’s arrival in the White House later this month, and whether Britain will be caught up in a feared trade war with the EU.
But perhaps the biggest threat is the long-term malaise that seems to have a grip on the UK, along with much of the West.
The focus on that will soon sharpen unless Labour can demonstrate that its approach is really going to improve UK productivity, spread wealth and ease the reliance on migration.