(Bloomberg) -- Chancellor of the Exchequer Rachel Reeves will speak in Parliament for the first time on Tuesday since the UK was rocked by market turbulence, one of several potential flash-points for the Labour leadership this week.
Reeves’ appearance in the House of Commons is officially to give a statement about the recent trip to China, yet allows opposition parties to quiz her on a sharp rise in gilt yields that risks leaving the chancellor in breach of her own fiscal rules. Further dangers lurk throughout the coming days, with government bond sales and crucial economic updates threatening to stoke the crisis.
Adding to troubles in the gilt market, the pound has also dropped around four cents against the dollar in less than a week, amid widespread concern over the country’s debt pile, anemic growth and stubborn price pressures.
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Though Britain’s finance minister has been trying to present a calm persona in the face of the market ructions, an inflation overshoot on Wednesday combined with weaker-than-expected growth data on Thursday may even force the Bank of England to intervene, economists warned. Such a scenario would intensify pressure on Reeves to lift taxes or cut spending, and put the entire economic agenda of Prime Minister Keir Starmer’s Labour Party at risk.
Reeves is grappling with the UK being at the center of a global bond market storm, driven by signs of an overheating US economy and the threat of a new round of damaging trade wars after incoming President Donald Trump’s inauguration on Jan. 20. She’s also paying the price for leaving herself just £9.9 billion ($12 billion) of headroom against her main fiscal rule at her budget in October — which requires day-to-day spending to be covered by tax receipts — a margin that’s estimated to have been wiped out by a higher debt-interest bill.
The yield of 10-year gilts, a typical way of measuring UK government borrowing costs, has jumped to a 17-year high on fears that the country is in the grip of “stagflation,” the dismal combination of high inflation and weak growth.
There was some respite for Reeves on Tuesday as yields eased for the first time in over a week and the government received solid demand for a sale of 30-year inflation-linked bonds.
“There will be a bit of a sigh of relief in the Treasury this morning,” Rupert Harrison, who was an aide and economic adviser to former chancellor George Osborne, told Bloomberg Television in an interview. “But of course, they’re not out of the danger zone. We’ve got UK inflation data tomorrow, which I think will be a key driver of gilt yields and markets very nervously watching, particularly services inflation.”
A shock spike in UK inflation on Wednesday is likely to “push yields up further,” said Centre for Economics and Business Research chief economic adviser Vicky Pryce. The Bank of England “would need to send a signal, otherwise markets will possibly go on strike. They could stop doing active QT,” she said, referring to Threadneedle Street’s scheduled £13 billion sale of gilts in the year to October.
Last month, BOE Governor Andrew Bailey signaled four quarter-point rate cuts were likely in 2025. Yet on Monday, markets were predicting just one full cut. Pryce said the BOE needed to push back against such market pricing, which would restore some of the £10 billion fiscal headroom that higher borrowing costs have erased since Labour’s October budget.
At current market rates, Reeves will have to find new savings. Pryce suggested Reeves should “defer some of her spending until later years” and “accelerate some cuts” to get a grip on the public finances.
Still, not everyone agrees that the BOE should intervene in the market ructions. DeAnne Julius, a former BOE rate-setter, told Bloomberg that it would be “dangerous to think that the markets are miscalibrating” the pressures on the UK and cautioned against any BOE intervention. “They just have to ride it out,” she said.
Inflationary threats may yet get worse as Reeves’ £26 billion increase in national insurance, a payroll tax, comes into effect in April, at which point businesses may start passing the cost on to customers in higher prices, she added. The weaker pound is also aggravating inflation.
Dan Hanson, chief UK economist at Bloomberg Economics, said the BOE should be in no rush to act. “Its February rate decision is a little over three weeks away,” he said. “If the Bank wants to say something, that’s the time to do it.”
Chasing the Market
In response to the market movements during her trip to China, Reeves said her fiscal rules are “non-negotiable” and that she’d take action to ensure they’re met, without being more specific. Privately, people familiar with the matter say the chancellor is considering spending cuts to stabilize the fiscal position.
Simon French, chief economist at Panmure Liberum, said the Treasury should be “working on savings in case they are needed for March 26,” when the Office for Budget Responsibility updates the chancellor’s forecasts. If borrowing costs do not drop back, Reeves will have to find money from somewhere.
Britain’s opposition political parties have been calling on the chancellor to make a formal intervention sooner to address the situation. For now, Reeves plans to stick to the previously-announced timetable of making a set-piece economic statement on March 26, according to people familiar with the matter.
Her deputy Darren Jones told parliamentary colleagues last week that markets “continue to function in an orderly way” and cited rising bond yields across the world.
In addition to her Commons statement on Tuesday, Reeves is due to meet a group of Britain’s regulators this week to push them to do more to facilitate economic growth. She’s also due to make a growth-focused speech in the last week of January.
Reeves received the fulsome backing of Starmer on Monday, who said he had “full confidence” in his chancellor.
“Rachel Reeves is doing a fantastic job,” Starmer told reporters at a press conference after delivering a speech on artificial intelligence in London. “We do have in place fiscal rules which we absolutely stick to because they’re necessary to provide the stability we want.”
