204. Will The Late Late Budget Heal Or Harm?

0:00Steph McGovern:Markets decide how much to charge us for borrowing money based on how likely they think we're going to be able to pay back these debts. And sometimes it doesn't feel like you get a fair hearing, I guess.

0:12Robert Peston:I'm afraid just welcome to the real world. It's a bit like complaining that the tide's coming in.

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2:05Robert Peston:Queen Carvania stood haloed by the morning sun. An army hung on her every word.

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2:44Steph McGovern:hello and welcome to the rest is money with me steph mcgovern and with me robert peston and oh man i've got loads i want to ask you today robert because it is it feels like we're in some type of chaotic meltdown for no good reason so um should we chat first of all of where we're at so we know now we've been waiting haven't we to hear when the budget is going to be so this is going to be Rachel Reeves' next attempt at trying to essentially plug the black hole, convince the markets that she's on top of the finances and basically make us look more economically stable than we currently do look. So it's now been announced it's going to be the 26th of November, which is, I mean, if you compare that to last year, last year it was around Halloween it's much later this time Robert isn't it so it very much feels like they're buying themselves time here what do you reckon?

3:42Robert Peston:Oh gosh yes it's definitely no accident as it were that this is the last possible moment they can hold an autumn budget and I mean just the first thing to say is quite how extraordinary it is that for the second year running, this government is defining itself by this so-called fiscal event. I mean, as you'll remember, the early weeks and months of the Keir Starmer government were all about the tax raising, the borrowing and the spending that he would do in a budget that was supposed to be the one-off reset of the public finances and public services. But it hasn't turned out that way. We're back here again with a second budget, which actually in some ways feels more momentous than the first budget, partly because there's been, you know, for reasons that may not be wholly rational, but there has been a progressive loss of confidence in the UK, in this government stewardship of the economy, by those who lend to the UK, by investors in UK government bonds.

5:18Robert Peston:And, you know, just this week, we have seen the interest rate paid, the yield on the government's long-term debt. These are 30-year government bonds, 30-year gilts rising to levels we have not seen since 1998. And this is at a time when the Bank of England is bringing down short-term interest rates. So you've got essentially the average cost of borrowing for the government going up at the time that the Bank of England is trying to bring down interest rates, which is a signal of declining confidence in the UK by these by these lenders. And B, also just very painful for the government, because something like every half percent rise in the average interest rate that it has to pay is the equivalent of six billion pounds of revenue that could otherwise be spent on public services.

6:25Robert Peston:You know, if it was a half percent lower, that would fund six billion of tax cuts or more spending. So, you know, this rise in average interest rates is both symbolically and materially painful.

6:39Steph McGovern:And, you know, if you just put this into context, as you say, it was this time last year when Rachel Reeves announced this mega budget. And that was, you know, over 40 billion pounds worth of tax increases. and at the time was seen as this massive epic event in terms of fiscal policy you know comparing this to other tax raising budgets this was the biggest you know the closest was Norman Lamont back in the 90s and then before that was the Dennis Healey budget of the 1970s shortly before he had to go cap in hand to the IMF to ask them essentially for a bailout which keeps cropping up at the minute because lots of people are also talking about that.

7:26Steph McGovern:I know you, Robert, have said that's not going to happen. They're not going to need to go to the IMF. There's quite a few other people saying they might have to do that, including the former Tory Chancellor, Ken Clark, also the former head of the National Institute of Economic and Social Research, has said, you know, we're showing signs that we might have to go to the IMF. And yet now we're talking about this other massive tax raising budget we're going to need to have a year later and at the same time all of the economic signals we look at we've talked about bond markets also the pound has fallen we've seen that fall against the dollar and the euro we're now our borrowing costs are the highest in the g7 how did we get into this mess how can we be a year later after this mega budget be talking about another one.

8:17Robert Peston:I think it is also worth just reflecting for a moment how much this is a crisis or a mess, shall we say, of their own making. Because, you know, on the one hand, it is certainly the case that there are some things that have had a damaging effect on the public finances that are beyond their control. So, you know, we've talked on this podcast about how so much of Trump's economics, whether it's tariffs, whether it is borrowing funded tax cuts, whether it's his attack on the independence of the US Federal Reserve, You know, all of this stuff has been perceived by markets as putting up not just underlying American inflation, but global inflation, the amount that the American government, particularly at the longer end.

9:16Robert Peston:So there are some global trends here, but it has been worse in the UK. Right. Investors have picked out the UK as more vulnerable. So our bond yields have gone up in this country more than they've gone up in America. So it's not reasonable for her to say this is all the rest of the world's fault. And, you know, you'll never hear anyway, either her or the prime minister actually say it's Trump's fault because they don't want to upset him. But she can't load all of this, as I say, on external factors because things are worse here. But secondly, some of what's gone wrong, you know, is down to some to some risky bets that she made.

10:04Robert Peston:You know, what now looks like quite serious misjudgment in her last budget. You know, she raised, you know, a staggering 40 billion in taxes. But the headroom, despite this these massive tax rises, because of the combination of what she was doing in terms of increased borrowing and increased investment and spending was tiny by historic standards. It was nine billion pounds. Now, you have to put that so-called headroom. And this is the sort of cushion that she has against whether she meets or flunks her fiscal rules. Right now, the typical swing between budgets over the last 20 odd years in terms of the margin of comfort against fiscal rules is something like 20 billion.

10:55Robert Peston:So if you've only left yourself nine billion, the odds are that you might get lucky. She's like a gambler. Right. You know, if you put everything on red and it comes up red, you know, you take home the pot and you look super smart. But you should not be running the public finances as a gamble. You know, if there'd been a 20 billion swing in her direction, great. She wouldn't have to. She wouldn't be putting up taxes now. But given the global uncertainties that she inherited, you know, let's be clear, at the time of the last budget, it wasn't we didn't exactly have a stable global world. You know, there was always a high probability that the 20 billion was going to go in the wrong direction.

11:38Robert Peston:And actually, all the analysis suggests that the swing is considerably more than 20 billion. She may end up having to raise something like 30 billion quid, which that would imply that there's been a move from a 9 billion surplus to a 30 billion deficit. Right. Or even more than that. So the swing could end up being more than that 20 billion against her. Now, she might say, ah, but Jeremy Hunt did the same thing. Yeah, Jeremy Hunt did do pretty much the same thing. But Jeremy Hunt was a chancellor who inherited a desperate situation from Liz Truss and her mini budget, you know, and was heading into an election.

12:23Robert Peston:And, you know, look, just be realistic about politics. People don't tend to whack out taxes before a general election. Jeremy Hunt may have also been reckless. And he was. But the politics dictated that. She had just won a landslide election. This was her one chance to reset the public finances. this was not the moment to repeat that punt right um and all she had to do was go back and look at other budgets over the preceding 20 years to realize quite how reckless you know keeping the headroom at nine billion was so let's be absolutely clear you cannot absolve her of you know essentially blame for the mess that she's in now yeah there's a few things i want to pick up on that firstly

13:15Steph McGovern:you know you mentioned Liz Trust there in the mini budget and just to remind everyone again what we where we were at in terms of borrowing costs at that point so you remember it suddenly shot up to five percent on those 30 year guilt yields um we're currently at over 5.6 percent so you know we're it's it is now more expensive for the government to borrow money than it was at that moment when Liz Truss, you know, everyone talks about dramatically kibosh the economy by pushing borrowing costs up. So we're already ahead of that. But the thing that I don't think is her fault, and you're right, like, you know, there's a lot of mismanagement here.

13:55Steph McGovern:And I think personally, sticking to this election manifesto of not taxing working people is part of the reason they've got into this mess, because putting the burden on businesses means that businesses are making decisions which impact the economy, such as, you know, not hiring as many people.

14:12Robert Peston:But also on that point, Steph, as you absolutely rightly point out, you know, part of the problem with the increase in the last budget in employers' national insurance is that has contributed to prices going up, to inflation being a bit higher than it otherwise would have been. And that contributed to interest costs being higher than they would otherwise have been. and that has led to the headroom being less than it otherwise would have been. So that was, again, another judgment that she made that contributed to the problems that she's currently facing.

14:46Steph McGovern:Yes, but the only thing I would say is, and I agree with you on all of that, and this isn't me defending her, but there is, and we've talked about this debt spiral before, you know, markets decide how much to charge us for borrowing money based on how likely they think we're going to be able to pay back these debts by how economically stable they think we are, by how well managed the economy is. But the problem is, if they think we're not looking good, it pushes up our cost. Then that makes our debt problems worse. So then we look worse. So then the costs go up again and you get into this debt spiral.

15:22Steph McGovern:And it does feel like it's markets that run our economy and what their perception is about how well we're performing. and that controls the economy more than the politicians themselves because, for example, we're talking about this budget needs to convince the markets that she's on top of things and that just feels wrong to me. It feels like she should be convincing all of us and you might say, yes, okay, the markets are us but it plays into this short-termism of decisions being made on how the bond markets are going to react. And sometimes it doesn't feel like you get a fair hearing, I guess, on more longer-term plans that might put pressure on us and on the economy in the short term, but actually play out in more economic growth.

16:16Steph McGovern:Like take, for example, Germany. Like Germany's bond yields have gone up after they've announced a big increase in spending on defence and infrastructure. But similarly, that increase in spending could be the thing that saves them longer term because it will create jobs, it will increase, hopefully, productivity, and it will therefore increase tax revenues. And it could be that that actually helps Germany in the longer term and that is the gamble that's paid off for them. But as things stand, the markets judge them on whether they can afford it now. And that plays into the short-termism, which I think is really hard as a chancellor to get beyond because you're constantly being judged by the reactions of the markets.

16:58Robert Peston:Yeah, I mean, let's be absolutely clear. Germany hasn't been remotely punished in the way we have. And also their public finances started from a way stronger position, their national debt.

17:10Steph McGovern:But their bond yields are still higher than they were in 2011. They're the highest, their bond yields since 2011. So they've definitely been more.

17:18Robert Peston:You could argue, actually, on your economic point, they are making a very sensible judgment, both to increase defence spending and infrastructure spending and try and stimulate growth. And they had the headroom to do that because they are actually able, given they start with way lower debt than the UK, they are able to borrow more on growth-enhancing investment. But, I mean, just on your main point, look, none of us like the fact that global markets boss countries around in terms of their economic decision-making, but I'm afraid just welcome to the real world. I mean, this has been the fact this has been, you know, essentially a fact of life since capital controls were dismantled, you know, having 45, you know, progressively dismantled 45, 50 years ago.

18:07Robert Peston:You know, if if investors don't want to lend to you, that is just a problem you've you've you've got. And there's no you know, it's a bit like complaining that the tide's coming in. You know, it's perfectly reasonable to say we wish markets weren't so powerful, investors weren't so powerful, but the facts are the facts. And we all wish that we had more stability in debt markets at the moment. And we all wish that, you know, investors in the UK took a slightly more optimistic view. And actually, one of the things that is true about the UK and actually Chris Charles and the FT has pointed this out, is that in many ways, the health of our public finances is better than the health of America's public finances and France's public finances.

18:59Robert Peston:So the question is, why are they singling out the UK compared to other countries? And, you know, it seems to me we should probably come back to that after a quick break. This episode is brought to you by Accenture.

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20:08Steph McGovern:Hey Chicago, class it up with Crocs. You know back to school is coming in fast. So why wait to find your new fave footwear? Step into a local Crocs store and step into your new look. Try it, style it, make it yours. Because the right pair doesn't just show up, it shows off. First day fits, handled. Walk out ready for whatever's next. Visit your nearest Crocs store today. okie dokie let's get back to our chat on the upcoming budget which we know now is going to be the 26th of november put the date in your diary make sure you've got your snacks ready because it's going to be a biggie um but we were talking robert earlier just about why we are being treated so differently to other countries now obviously some of the labour contingent are arguing that we're not there you know there was the uh spencer life and all the treasury minister saying that the movements are orderly in the bond markets and they're in line with global peers we're very much saying no they're not we're getting hammering compared to them is it about inflation is it do you think part of the problem is we have a bigger problem in the uk with tackling inflation you know and that kind of dependency on importing as well lots of products and just the fact that we we haven't got on top properly yet of of prices going up look let's be absolutely clear you know

21:34Robert Peston:inflation expectations in the UK are higher than they are in much of Europe, even in America. There are a couple of other reasons, though, why the UK is, despite the fact that, you know, national debt is a share of national income lower than America, lower than France. People look at us askance. One reason is because so much of the demand for government debt, gilts, came from the final salary defined benefit pension schemes that are being wound down for all sorts of you know regulatory reasons which are not this chancellor's fault they are the fault of previous governments these gold-plated pension schemes are broadly being wound down by their corporate sponsors and they were the big buyers of gilts so that is a source of demand for government debt that is progressively falling and there is you know very very little that she can do about that.

22:49Robert Peston:And it also comes, this fall in demand for guilt also comes at a time when the Bank of England is behaving differently from other central banks. And, you know, it is selling some of the stock of the government debt that it bought when it did all that money creation through quantitative easing after the financial crisis and during the COVID crisis. You'll remember that there was these exceptional changes in monetary policy by the Bank of England to cope with, as I say, the aftermath of the financial crisis and then COVID, where they bought hundreds of billions of pounds of UK government debt. And that actually supported the gilt price that actually forced interest rates paid by the government lower.

23:39Robert Peston:They are now because of the rise of inflation over the past couple of years, they are now selling their stock of guilt. So at the same time as the government has to borrow, there's another tranche of government debt that investors outside have to pick up. And so there's an excess of supply over demand. And that, of course, means the interest rate paid goes up as the price of that debt falls. Right. So there are a whole combination of these structural factors, which you could argue are not the Chancellor's fault. There will be a very, very interesting decision that will be taken at the next meeting of the Bank of England's monetary policy committee, which is actually whether to continue to sell gilts, to engage in so-called quantitative tightening on this scale.

24:33Robert Peston:The problem for the Bank of England is that if it were to significantly reduce the amount of gilts that it is selling at a time when inflationary expectations in the UK are higher than elsewhere, the worry for the Bank of England would be that it would be accused of essentially trying, helping to bail out the government. and people would then say, oh, well, if it's bailing out the government and it's not focused on inflationary conditions, it's not independent enough. And the last thing it wants to be seen, to be doing, is in a sense to be taking decisions that are politically driven because that way lies the end of independence and indeed ultimately could erode confidence in the Bank of England's independence and force interest rates up higher.

25:27Robert Peston:So, you know, this is a tricky set of circumstances.

25:32Steph McGovern:That's a total head melt, because if you think about, as you say, the purpose of the Bank of England, surely if it's in all of our interest for the borrowing costs to not go up anymore and hopefully come down, then that is for the greater economic good. But as you say, it looks political because it would also help out the Labour Party. But surely when they're making decisions on interest rates, which obviously are used as a monetary policy to try and control inflation, that also helps the government because they always use that as a tool to say, well, inflation's under control under our steering of the economy.

26:18Steph McGovern:so isn't it a bit like saying we're not going to put up taxes for working people because that was in our manifesto but working people are going to be hit by it anyway surely the bank of england could say we need to do this to help the economy and yes it looks like it's partisan it looks like it's helping the labour party it looks like it's helping the government but actually it's for the