At a dinner in the City hosted by two of Britain’s most senior bankers in late October, the discussion over the claret was dominated by concerns about Rachel Reeves‘s budget to follow a month later.
The Chancellor and her advisers had been on a mission to convince the media, the public and the financial markets, through an unprecedented number of leaks and private briefings, that a giant black hole had opened in the public finances.
By talking down the economy week after week, Reeves had sapped business and consumer confidence in the run-up to the Budget and everyone knew that she would be announcing new taxes on November 26.
A few days after that gloomy dinner, she delivered her coup de grace.
In her now notorious November 4 ‘Cheerios’ speech – so-called because it was delivered at breakfast time – she said that a combination of tariffs, inflation, higher borrowing costs and poor productivity had played havoc with the nation’s finances and dropped a heavy hint that she would be forced to break Labour‘s manifesto commitment not to raise income tax.
‘What I want people to understand ahead of the Budget is the circumstances we face,’ said Reeves, adding ominously: ‘All will have to contribute.’
The underlying message was that tax rises were coming and voters needed to brace themselves for the onslaught.
But what is bad news for consumers can have the opposite effect on City sentiment. No sooner had the Chancellor finished speaking than gilt yields, the interest rate returns on government stock, fell – a sure sign of market confidence.
Bond dealers had become convinced they could place their trust in the ‘Iron Chancellor’ to take the necessary steps to plug the supposed black hole, without resorting to yet more borrowing.
By talking down the economy week after week, Reeves had sapped business and consumer confidence in the run-up to the Budget
No sooner had the Chancellor finished speaking than gilt yields, the interest rate returns on government stock, fell – a sure sign of market confidence
But certain City players thrive on economic uncertainty and market volatility. In the wake of Reeves’s doom-laden address, the pound plunged to a seven-month low.
And foreign exchange dealers were not the only traders making hay.
The greater the flow of information – or misinformation, for that matter – the greater the opportunities there are for the ‘macro’ hedge funds, peopled by the sort of ‘big swinging d***’ bond dealers made famous by the author Michael Lewis in his book Liar’s Poker, to turn quick profits.
The smallest adjustment in bond prices, when translated into complex derivative products, could yield vast earnings.
In the testosterone-fuelled trading rooms of the Square Mile, bets against the pound and gilts can produce big trading profits, which can, in turn, leave ordinary retailer investors, with little access to such exotic instruments, nursing losses.
This phenomenon prompted both the Tories and Reform to accuse the Government of effectively creating a ‘false market’ by delivering a series of botched briefings.
That is why they have demanded that the City regulator, the Financial Conduct Authority, investigate the conduct of Reeves and those around her to determine whether it amounted to market manipulation.
And no briefing was more misleading than the speech and huddle with the Press that Reeves gave at Downing Street on November 4.
Weeks before the Budget, members of the Chancellor’s inner circle let it be known that the public finances watchdog, the Office for Budget Responsibility (OBR), had reassessed its judgment of the productivity of the UK economy and this meant a downgrade of 0.3 per cent.
It may sound like a tiny amount but it has huge consequences. Indeed, using that figure as a guideline, analysts in the trading rooms of the investment banks and hedge funds, which dominate financial trades, reckoned that the Chancellor would need to find £30 billion to keep within the fiscal rules Reeves had set the Government a year earlier.
These demanded that the Government fund all current spending out of taxation and/or cuts in the size of government rather than borrowing.
At no point did Reeves or the clique around her seek to disabuse the financial and political Press, City economists, or anyone else of the notion that there was a multibillion black hole in the public finances to be filled.
It was against this background that Reeves delivered her highly unorthodox Cheerios address.
We now know that by the time she gave that speech, she had been told by the OBR that the productivity downgrade’ had been offset by larger than expected tax revenues due to rising wages and inflation driving workers into higher tax brackets.
The Chancellor still had £4.2billion of headroom in her current budget.
The picture she had painted of a country in a state of financial crisis was nothing but a self-serving fiction peddled so that, on Budget day, Starmer and Reeves could buy off their turbulent backbenchers with an end to the Tory-imposed two-child benefit cap.
But two days later, the Government did nothing to deny newspaper reports that a two-pence rise in income tax rates was on the cards.
Bond yields dropped by as much as 2 per cent as traders were bolstered not only by Reeves’s hardline rhetoric but also by the prospect of interest rate cuts on both sides of the Atlantic.
Traders and investors who had placed their faith in Reeves felt vindicated.
It was once the case that the bond markets, where the UK government goes to borrow money to finance its deficit and debt, were largely immune to the day-to-day remarks of politicians. Most bonds were held by Britain’s big battalion of pension funds and insurance giants, but the slow death of gold-plated pension funds (thanks to tax changes introduced by Gordon Brown when chancellor), saw the rise of the defined contribution fund.
This led to more adventurous investments by managers seeking better returns on Wall Street and around the globe.
The proportion of gilts held by UK investors plummeted to around 50 per cent, prompting the then governor of the Bank of England Mark Carney (now Canada’s Prime Minister) to argue that Britain’s financial stability had become dependent on the ‘kindness of strangers’.
Just how fickle these strangers could be became most obvious in September 2022 when the markets went in paroxysm after the Liz Truss-Kwasi Kwarteng mini-budget.
A much milder display of their displeasure came on November 13, nine days after Rachel Reeves’s Cheerios speech, when there was yet another bombshell pre-Budget leak: there would be no income rise, after all.
The bond markets took fright, there was a significant rise in interest rate yields –amounting to four per cent of the price of ten-year gilts –and big enough to undo all previous gains.
Downing Street, Reeves and her team had played right into the hands of the tumultuous global markets.
The volatility her shock announcement created will have been a gift for the hedge funds and investment banks who like nothing better than taking short-term punts on markets. And we can expect to see the gains made when financial results for the final quarter of the calendar year start to appear early in 2026.
But smaller retail investors and more conservative, less fleet-of-foot pension fund managers will have been on the wrong side of some of those trades and seen some of their hard-earned savings diminished if not wiped out.
Labour’s cack-handed management of the public finances not only means ever-rising taxes, but it will also have robbed ordinary savers of the sort of superior returns enjoyed by the fat cats.