(Bloomberg) -- Britain’s Labour government may have to ditch its manifesto promise not to raise taxes on working people if market interest rates rise much further, according to former Bank of England rate-setter Martin Weale.
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Speaking to Bloomberg Radio, Weale said he could see “some circumstances in which they will have to eat their words” such as “if interest rates rise considerably further.” Chancellor of the Exchequer Rachel Reeves would then be left with little option but to target VAT or income tax to stick to what she has called her “non-negotiable” fiscal rules.
Labour ruled out these tax increases on everyday people ahead of its landslide election victory last summer, but the economic outlook has since deteriorated.
The UK government has been rocked by this week’s bond market selloff that has driven up the cost of borrowing and hit the pound. Economists say investors are worried that Reeves’ budget plans will not deliver the growth required to bring the national debt under control and may stoke inflation.
Weale said the market moves so far have been fairly small and it was “perfectly responsible” for the chancellor to go ahead with her trip to China this weekend. “I don’t get a sense of a market panic,” he said. “It’s more an issue that is going to be addressed but doesn’t need to be addressed on Monday.”
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However, he said the next test of UK markets may come this afternoon, when the US releases its latest jobs report as UK bonds are being driven in part by what is happening in America. “If rates look like staying higher this afternoon after the jobs report we may see a further increase in UK yields,” Weale said.
Bloomberg Economics has calculated that Reeves’ slim £9.9 billion ($12.2 billion) headroom against her main fiscal rule has been more than wiped out by the rise in borrowing costs. The government has signalled it plans to cut departmental spending to keep a lid on the national debt, which at 98% of GDP is the highest it has been since the early 1960s.
Weale said scrapping the fiscal rules would be most dangerous course of action and “might be one thing that could trigger a Liz Truss episode.” He was referring to the market panic sparked by the former prime minister’s tax-cutting mini-budget in 2022. He also drew a comparison with the 1976 sterling crisis, when the pound was similarly falling as borrowing costs rose.