Investors around the world are continuing to sell off government bonds, which means borrowing – for the state, 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 organisations and politicians have chosen to attribute the rise in UK gilts yields entirely to what Kemi Badenoch has taken to calling a “Burnham premium”. This suggests that either Kemi Badenoch doesn’t understand the forces that removed her party from government, or she’s happy to misrepresent them to her voters. Perhaps a bit of both.
What is true is that the market is extracting higher yields (debt servicing costs, or interest) from UK debt than from that of 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 such as France (116 per cent), America (123 per cent) and even Italy (137 per cent) commands higher prices (and therefore lower yields) than Britain’s bonds.
Fortunately, there are some steps an incoming Prime Minister could make to address this situation. Unfortunately, they might not be enormously popular.
Take it Reevesy
Since July 2024, Rachel Reeves has not so much as ordered a coffee without reaffirming that the spending implied would be within her fiscal rules. One positive signal to the bond market would be to maintain Reeves’ position, either in person, by literally keeping Reeves as Chancellor, or in spirit, by publicly stating – as often as possible – that you also consider these rules immovable.
Subscribe to the New Statesman for £1 a week
However, the rules are only half the picture: you also need credibility.
Beat the backbenchers
It’s not sensible to argue that there is a significant “Burnham premium” on UK bond yields, because the market doesn’t have enough information on Burnham’s policies to price them. There may however be a Starmer premium, because the market does know that the current PM hasn’t been able to impose cost-cutting policies such as removing the winter fuel allowance or reforming the benefits system. If you can’t impose fiscal consolidation with more than 400 MPs, then as far as the market is concerned you might as well not have a majority. A new PM who was better at selling policy to the rebels – or more ruthless about imposing their plans – might increase the credibility of the government’s plans in the market.
Just raise tax (differently)
In very general terms the market tends to “prefer” (yes, it doesn’t prefer anything, it’s a huge set of constantly changing investment decisions, but let’s anthropomorphise it or we’ll be here all day) spending cuts to higher taxes. The fiscal impact of cutting spending is clearer (people can change their behaviour to avoid tax, they can’t make the government spend more money) and cuts can also reduce inflation (which makes bonds less valuable to investors), at least in the short term. In the long term, however, you need to invest if you want economic growth. If you want to do fiscal consolidation without slashing public spending, raising taxes is the other lever you can pull. Not by changing a handful of taxes slightly to get things to fit the OBR forecast: big, bold reform of a dysfunctional tax system would solve a lot of issues. One possible hitch is that failing to address the dysfunctional tax system was a core element of Labour’s 2024 manifesto. Maybe it would just be easier to…
Rejoin the EU and sign up to the Euro
The reason 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 lower inflation. It also means sharing a central bank – the European Central Bank, or ECB – which maintains lower base rates than the Bank of England and does more to defend bond prices (the BoE has been accused of going in the other direction, by selling more bonds back into the market). The European debt market is much larger than the UK’s – trading volumes in the secondary market are about three times larger – and this means there is more demand. We would pay less for our debt as Europeans.
There might be a few voters who would find rejoining the EU and adopting the euro controversial; what’s an extra £50,000 on the mortgage when you get to use coins with a picture of the King on them?
End the war in Iran
The real reason government bonds are selling off around the world is the fact that the US and Israel have begun a war on 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 rise this has caused, which erodes the value of bonds. Another measure that would reduce bond yields would be to simply bring about an end to the war in Iran, and ideally also Russia’s war on Ukraine. Or failing that…
The Mili-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 rise in the wholesale price of gas will produce more inflation in Britain than in other European countries. We are heavily dependent on gas for home heating and unusually dependent on cars for transport. 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 are obviously going to keep doing. 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 comes at a political cost, because there are people who prefer sheep farms to solar farms, or who think insulation is woke. But look at the way gilt yields rose in 2022: the spike in yields actually began well before the Truss “mini-budget”, when she announced her other major policy, the Energy Price Guarantee, which connected government borrowing to the energy market. This is one reading of Andy Burnham’s famous comment to the New Statesman about being “in hock” to the bond markets: the UK has a debt premium because, after a very long period of low investment, we don’t have enough control of our spending.
[Further reading: Wes Streeting reopens the Brexit box]
Content from our partners