The governor of the Bank of England has fired off a pre-Budget warning that the Chancellor must balance the books or face a renewed bond market storm.
As UK long-term borrowing costs surged to a fresh 28-year high yesterday, Andrew Bailey warned worse could come should traders ‘begin to doubt the fiscal trajectory’.
In a speech three weeks before John Healey delivers his first Budget, Mr Bailey said in that scenario ‘bond yields can rise further’.
That would mean ‘tightening monetary and financial conditions’ – code for higher interest rates and a squeeze on lending by commercial banks.
Mr Bailey said government tax and spending policy must ‘be seen by markets as credible’ and stressed the importance of sticking to fiscal rules.
His speech in Istanbul was headlined on the broader theme of ‘financial resilience’ amid uncertainty caused by the war in Iran and the rise of artificial intelligence (AI).
Andrew Bailey said governments must deliver ‘credible’ fiscal policy
But his remarks on fiscal policy – the way in which governments tax and spend – are certain to be viewed through the lens of Mr Healey’s Budget coming up on 28 October.
Tory shadow Chancellor Andrew Griffith said: ‘In central banker speak this is a clear warning to the government to get a grip on their debt-fuelled spending binge.’
It comes after, earlier this week, the PM’s one-time advisor Andy Haldane – a former chief economist at the Bank of England – warned that the UK was ‘skating on thin ice’.
Investors are increasingly anxious about how the Chancellor will be able to find the money to fund cost of living help, higher defence spending, a council house building spree and an overhaul of social care – all ambitions of the Prime Minister.
Many fear Mr Healey could turn to growth-sapping tax hikes to add to the £75 billion piled onto the economy by Rachel Reeves – and doubt that Mr Healey is instead prepared to take an axe to Britain’s ballooning benefits bill to make the sums add up.
Those fears have added to the pressure on UK bonds, known as gilts. Like other bonds around the world, they have suffered a sell-off since the start of the Middle East war and the resultant rise in oil prices and inflation pressures.
As gilt prices fall, yields rise – adding to borrowing costs. Mr Burnham’s recently reiterated insistence that he does not wish to be ‘in hock’ to bond markets has done nothing to help.
The market turbulence has slashed the Budget ‘headroom’ available to Mr Healey. Experts believe it has more than halved from £24 billion since the spring.
A report earlier this week from EY warned that this could even turn into a £7 billion black hole should the war drag on into next year.
Yesterday, as the oil price spiked above $105, yields on ten-year gilts jumped above 5.52 per cent, the highest level since 2007. Just before Mr Burnham became PM they sat below 5 per cent.
And yields on 30-year gilts spiked above 6.04 per cent yesterday, the highest level since 1998.
Mr Bailey warned that lower growth and repeated global shocks weakened public finances even as governments come under pressure to provide cost of living support, while higher borrowing costs add to the debt pile.
‘If markets begin to doubt the fiscal trajectory, bond yields can rise further, tightening monetary and financial conditions,’ he said.
And while governments can ordinarily splash out in times of crisis – and pay for it later – this becomes ‘much harder to sustain’ when ‘shocks become more frequent’, Mr Bailey added.
The remarks come days after Mr Haldane warned: ‘We are skating on pretty thin ice in fiscal terms, and nothing would be worse both economically and politically, than if the ice were to crack beneath our feet.’
He said the ‘single most effective way’ of stopping that and appeasing financial markets ‘is for this government to show that it’s able and willing to take the knife to public spending’.