Britain is hoovering up the wrong sort of records. In the wake of the Iran war, the economy is staring down the heaviest growth downgrades in the G7, the most stubborn inflation, the greatest exposure to volatile gas prices and some of the thinnest storage capacity in Europe. It is a sobering tally for any prime minister, never mind one whose backbenches are openly muttering about regicide.
Sir Keir Starmer’s insistence on Friday that he will not “walk away” from Downing Street steadied the ship for an afternoon. David Lammy, his deputy, urged colleagues against “changing the pilot during the flight”. Even John McDonnell, never knowingly off-message when there is mischief to be made, could only manage a tart “sometimes you do if you’re in a nosedive” before being reminded that Jeremy Corbyn’s hard-Left prospectus delivered Labour its worst drubbing since 1935.
But beneath the Westminster choreography, something more consequential is unfolding in the gilt market, and it is the small and medium-sized businesses that keep this country running who will feel it first.
Since hostilities flared in the Gulf, UK 10-year gilt yields have climbed by roughly three quarters of a percentage point, briefly nudging above 5 per cent, territory not seriously visited since the 2008 financial crisis. Thirty-year yields have hit their highest level since 1998. The moves have outpaced those in the United States and most of Europe, a worrying decoupling for an economy that has long depended on the goodwill of overseas capital.
This is not a Truss-style detonation. It is something arguably more troubling: a slow, persistent grind higher that is steadily reshaping the cost of borrowing for every business in the land.
Jim Reid at Deutsche Bank reminds clients that the UK’s structural fragility is the real story. Britain runs a negative net international investment position, foreigners own more of us than we own of them, leaving the country, in his elegant phrase, “reliant on the kindness of strangers” with “limited buffers against external shocks”. Recent Bank of England research suggests the position has been broadly stable since the 2016 referendum once foreign direct investment is stripped out. Reassuring, perhaps, but not exactly a fortress.
Markets have broken governments before. During the eurozone debt saga, Greek, Irish and Portuguese yields nudging towards 7 per cent forced their respective administrations into the arms of the IMF. Britain, mercifully, is not Greece. Simon French, chief UK economist at Panmure Liberum, points out that we control our own currency and therefore always have a buyer of last resort in Threadneedle Street. The Bank can, in extremis, simply print more pounds.
The trouble is the bill that arrives afterwards. “You’d pay a cost in terms of inflation and currency devaluation,” French notes. “So it’s more a slow death of a productive economy than a crash moment.” It is the entrepreneur staring at next quarter’s overdraft facility, not the hedge fund manager, who tends to do the dying in that scenario.
French sees a psychologically loaded threshold lurking just above current levels. “If the 10-year were to hit 5.5 per cent, the pressure would become very, very significant for the Bank to act.” With yields already at 4.9 per cent, the cushion is wafer thin. Andrew Bailey acknowledged the dilemma in a recent New York speech, conceding “more scope for conflict between the public good interest and private interests” when financial stability hangs in the balance — central banker shorthand for an unenviable judgement call.
The numbers tell their own story. The UK is now paying around £100bn a year servicing its debt, equivalent to nearly 8 per cent of all government revenues. Fitch, the ratings agency, points out that this is more than double the 3.7 per cent average for countries with a similar credit rating, and well in excess of France and Germany. “Sustained higher-than-expected yields are a key risk to our medium-term debt projections,” the agency warned in February.
For Britain’s 5.5 million small businesses, every basis point matters. Higher gilt yields ripple swiftly into commercial lending rates, asset finance, invoice discounting and the cost of fixed-rate mortgages held by the directors who, more often than not, are personally guaranteeing those very facilities.
In the meantime, the cast list of would-be successors lurks in the wings. Angela Rayner, the former deputy; Andy Burnham, the Mayor of Greater Manchester; and Wes Streeting, the Health Secretary, are each said to be quietly mapping their respective routes to No. 10.
Bond traders are watching closely, and not all combinations are equally palatable. Neil Mehta at RBC BlueBay warns that “if it’s Rayner or Burnham, the general reaction from bond markets is not going to be positive”. A Rayner-Burnham ticket with Ed Miliband as chancellor is the City’s particular nightmare. “This could actually linger for a while,” Mehta says, “and in that period, I think gilts will continue to underperform versus other markets.”
What the market wants, he adds, is rather prosaic: cost savings, restraint on spending, the unglamorous arithmetic of fiscal discipline. “If it’s going to lurch more to the Left, then the two options are you either borrow more or you tax more, which don’t seem like the solutions that would be most ideal.”
A more sanguine City voice suggests personalities are beside the point. “It’s all about fiscal discipline and delivering economic growth. The market will look through everything else.” Others are blunter. “Some of these people are so stupid they can’t even spell ‘bond,’” mutters one executive. And there is a further camp, moving in Labour circles, who have all but given up on incrementalism: “It’s the only way we will ever get serious change. Only a crisis will reset Britain.”
For now, investors are still showing up. Foreign buyers have been net purchasers of gilts for seven consecutive months and DMO auctions are still drawing roughly three bids for every bond offered. As French drily observes: “I’m not sure it’s a vote of confidence. I think all it’s telling you is that people like more money than less money.”
That may yet prove a slender thread on which to hang an economy. For Britain’s SMEs — already battered by inflation, energy costs and the ratchet of regulation — the message from the bond market is unambiguous. Whatever Labour decides to do next, it had better be priced in.
Buckle up, indeed.
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Bond markets sound the alarm as Labour wobbles and gilt yields climb