Britain compiles the wrong kind of records. In the wake of the Iran war, the economy is facing the most severe slowdown in growth in the G7, stubborn inflation, high exposure to volatile energy prices and the thinnest reserve capacity in Europe. It’s a sad statistic for any prime minister, never mind someone whose back is openly muttering about murder.
Sir Keir Starmer’s insistence on Friday that he would not “walk away” from Downing Street steadied the ship this afternoon. David Lammy, his deputy, urged his colleagues not to “change the pilot during the flight”. Even John McDonnell, never one to put out a deliberate message when something wrong is being done, could manage a “sometimes you do when you’re confused” tart before he was reminded that Jeremy Corbyn’s hard-Left views had delivered Labor its worst loss since 1935.
But underneath the Westminster choreography, something very important is happening in the gilt market, and it’s the small and medium-sized businesses that keep this country running that will hear it first.
Since the outbreak of war in the Gulf, UK 10-year yields have risen by around three-quarters of a percent, briefly edging above five percent, territory not visited since the 2008 financial crisis. Thirty-year yields hit their highest level since 1998. The measures have outstripped those of the United States and much of Europe, a worrying unwinding of economies that have long depended on the goodwill of overseas capital.
This is not a Truss style blast. It is undoubtedly the most worrying: the slow, steady grind that is slowly changing the cost of borrowing for every business in the country.
Jim Reid at Deutsche Bank is reminding clients that UK structural weakness is a real issue. Britain has a poor international investment climate, foreigners own more of us than we own, leaving the country, in his famous phrase, “relying on the kindness of strangers” with “limited buffers against external shocks”. The Bank of England’s latest research suggests that the position has been broadly stable since the 2016 survey if foreign direct investment is excluded. Confirmation, perhaps, but not necessarily a castle.
Markets have broken governments before. During the eurozone debt saga, Greek, Irish and Portuguese yields headed towards 7 percent and forced their managers into the arms of the IMF. Britain, kindly, is not Greece. Simon French, chief UK economist at Panmure Liberum, points out that we control our money so we always have a buyer of last resort on Threadneedle Street. The Bank can print more pounds.
The problem is the debt that comes after that. “You will pay the cost in terms of inflation and devaluation,” French noted. “So the slow death of a productive economy has a moment of collapse.” It’s the businessman staring at the next quarter’s overdraft facility, not the hedge fund manager, who usually dies in that situation.
French sees a psychologically loaded edge lurking above current levels. “If the 10-year could reach 5.5 percent, the pressure would be too great for the Bank to act.” With the yield already at 4.9 percent, the cushion is a little thin. Andrew Bailey acknowledged this problem in a recent speech in New York, allowing “great room for conflict between good public intentions and private interests” when financial stability hangs in the balance – central banker shorthand for an unparalleled judgment.
The numbers tell their own story. The UK now pays around £100bn a year to service its debt, which equates to around 8 per cent of all government revenue. Fitch, the rating agency, points out that this is more than double the 3.7 percent average for countries with similar credit ratings, and more than France and Germany. “Continued higher-than-expected yields are a significant risk to our medium-term credit projections,” the agency warned in February.
For Britain’s 5.5 million small businesses, every point counts. High-quality products are rapidly expanding into commercial lending, asset finance, invoice discounting and fixed-rate debt financing managed by directors who, in many cases, are guaranteeing those areas.
For now, the list of successors is lurking in the wings. Angela Rayner, former deputy; Andy Burnham, Mayor of Greater Manchester; and Wes Streeting, the Health Secretary, are each said to be quietly charting routes to Number 10.
Bond traders are taking a closer look, and not all combinations are equally palatable. Neil Mehta of RBC BlueBay warns that “if it’s Rayner or Burnham, the general reaction from bond markets will not be positive”. A Rayner-Burnham ticket with Ed Miliband as chancellor is a nightmare for the City. “This could go on for a while,” Mehta said, “and during that time, I think gilts will continue to underperform relative to other markets.”
What the market wants, he adds, is prosaic: cost savings, spending restraint, unglamorous accounting of financial behavior. “If it’s going to eat too much on the Left, the two options are to borrow more or pay more taxes, which don’t seem like very good solutions.”
Sanguine City’s voice suggests that people are close to the point. “It’s all about fiscal discipline and delivering economic growth. The market will take care of the rest.” Some are mistakes. “Some of these people are so stupid they can’t even say ‘relationship,'” lamented one official. And there is another camp, moving to Labor circles, who have given up hope of growth: “That’s the only way we’re going to get a big change. Only a crisis will restore Britain.”
Meanwhile, investors are still emerging. Foreign buyers have been buyers of gilts for seven months in a row and the DMO auction still attracts about three bids for every bond offered. As French drily notes: “I’m not sure it’s a vote of confidence.
That may yet prove a thin thread by which the economy can hang. For British SMEs – already battered by inflation, energy costs and the ratchet of regulation – the message from the bond markets is unclear. Whatever Labor decides to do next, it had better be priced.
Bind, of course.
