ALEX BRUMMER: Spending cuts are inevitable whoever is in cost

There will be relief at the Treasury and the Bank of England that the elections have not made bad conditions on bond markets worse.

The perception that lame duck Prime Minister Keir Starmer is determined to cling on to power promises temporary stability and postpones the prospect of a dangerous swing to the Left.

Britain’s political turmoil coincides with the annual visit to the UK by inspectors from the International Monetary Fund (IMF).

This is significant because British governments and HM Treasury are much more likely to listen to what the Fund says than the US and other G7 counterparts.

There has never been a British managing director of the IMF, but the input of John Maynard Keynes in creating the Bretton Woods institutions is not forgotten.

Both the IMF and UK Treasury believe in the integrity of fiscal rules. Even if the goal of cutting UK budget deficits and national debt drifts further into the distance, the target is not in doubt.

The problem is how to tackle the fallout from the crisis in the Strait of Hormuz, surging inflation and vanishing growth.

British options are limited by the peculiar volatility and high-level of yields on UK bonds and the profligate way in which Chancellor Rachel Reeves heaped taxes upon taxes to stabilise borrowing. Bringing order to the public finances should involve spending discipline.

Analysis by the IMF suggests Labour’s tax rises have stultified the jobs market, led to disincentives to work and created jagged distortions which punish growth.

The effective tax rate of 60 per cent on people earning about £100,000 a year is well documented. The overall level of UK taxes, although a peacetime high, is not out of line with European counterparts.

But the way they are being levied is creating a ‘Laffer Curve’ effect: the higher they go, the less revenues they generate.

Instead of tackling expenditure, Labour has added to it. It has been spent on the NHS, public sector wages, steel bailouts, the two-child benefit, breakfast clubs and the pensions triple lock. It has added to welfare bills through employers’ national insurance and employment rights.

The ultimate guardian of Britain’s fiscal fate is the gilts market. Reeves says our rates move in lockstep with the US, which is why they have been elevated since Trump came to office.

Yields are set by two factors. The monetary path – that is inflation and its impact on interest rates – and the risk premia: trust in government to resolve fiscal issues.

Historically, gilts were dated longer because this is what insurers, banks and pension funds wanted. Demand has diminished so the UK’s debt management office has issued gilts of shorter duration.

This has become a playground for hedge funds cashing in on volatility caused by the UK’s politics. Starmer has bought a fragile peace with the bond and sterling markets by hanging on. But unless he (or successors) takes a meat-axe to spending, there will be a catastrophic storm.