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Then comparisons are being made to this trust But is this more callahan than trusts?
Is this more seventy six than twenty two? Possibly?
What we are seeing in the UK, guy is a train break in slow motion. Welcome to the City of London, the.
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Pe So, Dave, we're putting a bonus episode out today because there's been a lot of turmoil for UK assets. Now this is probably not only a UK story, but they're definitely at the forefront of this global route sparked by I guess latest threats of tariffs and worries that inflation will remain elevated in the US for longer than expected.
Yeah, yeah, absolutely.
I mean, as I'm sitting here in New York and you know, there are echoes of a few years ago. Because the UK term on in the market is breaking through. People in New York and around the world are asking what's going on with the UK assets?
Why invest It seem to be fleeing.
We're seeing falls in stocks, falls and bonds and the pound at the same time.
All of that adds up to.
A real lack of confidence in the UK as a place to invest.
Yeah, and of course the global bond sell off is unnerving for many reasons. But of course it changes expectations on government's fiscal operations. So we're bringing you the special episode, this emergency edition of In the City to try and understand what it all means for the Chancellor of Rachel Reeves. I'm frontin Laqua in the London studio and.
I'm David Merritt here in New York.
And today we're discussing how the UK bond sell off is putting Rachel reeves economic projects on the brink, and with us Phil Aldrich, our senior reporter covering the UK economy and of course a regular on in the City. Phil, thank you so much for joining us. It's been a wild, wild week for UK assets.
Why that is the question. Why now it's a bit of a quandary. And obviously what's been happening is, you know, US bond markets have been moving, Donald Trump has been spooking people with tariffs. So there's this backdrop of sort of less certainty about the outlook, and the UK is has been most exposed of you know, the major economies
to that. We've seen this big increase in bond yields, so government boring costs are soaring, and the pound is falling, which is indicative of you know, capital flight in the UK.
So people are losing confidence in the UK assets. So why is it happening now, it seems that people have or why is it happening particularly to the UK's people will investors seem to be sort of taking the making a judgment that Reeves's budget isn't going to deliver what is necessary both to bring the debt on put the debt on a sustainable footing and to bring inflation down. And so there seems to be this kind of this
nervousness now about the outlook. But having said that, it seems a little unfair to put the UK right in the crosshairs of all this, given that we do have a we have a stable government. You know, by comparison, you might say France looks like a bit of a basket case at the moment, and yet the UK is the one that's really getting it in the neck.
I mean, Phil, I do remember the conversation we had when you came on after the budget and I was struck at the time. You were pretty surprised at the scale of the tax risers and the spending. It blew through your expectations. And you said at the time, I remember clearly we talked about this question about the headroom and we talked about how there isn't really a room for maneuver here if there's a bit of a shock.
And of course back then we didn't know that Donald Trump was going to win the election, and yet it was a big possibility and and you said, this is a risky budget. You know, there's there's not room from maneuver, and you know, and lo it came to pass and we've seen more turbines and markets in the UK has really copped it. I mean, I think you called it right, didn't you.
I'll tell you that one. It may have been one of the few times I did. But yeah, the thing is the headroom is is very thin. It's the third smallest headroom the Chancellor has had since the OBI was set up in twenty ten.
So is that how big mistake you think, like not trying to kind of put the country's finances on a more stable first thing and find public services. But she just didn't give herself enough room for maneuver in the world we're in now, I.
Think I think that was that was clearly a risk, and OBR clearly flagged that risk in the in the budget in October, and I do think that was an error. I mean, if she had gone with the sort of more traditional levels of headroom, which would be twenty five billion to thirty billion pounds, you know, this was sort of you know, pre twenty nineteen levels, then you know this would not have eroded. She would have eroaded half her headroom. She'd still have, you know, enough to say
I can meet my fiscal rules. The whole point about the headroom is it's a it's a buffer against unexpected shops. If you leave yourself nothing, which is you know this, as I say, it was the third slimmest headroom ever, then you know you are exposing your rules to movements in markets like this, and you know, if you're saying that, you know what you're trying to provide is fiscal stability
on which you can then build your growth program. And you've created such a such a small buffer that you end up creating policy instability because nobody knows how you're going to fill this hole. Should markets move against you, you may have to raise taxes, you may have to do spending cuts. You know that sort of completely undermines the sort of edifice of her project.
Yes, so basically, you know, if you have a lot of pain inflicted by these rapidly rising barring costs, if you have razor thin buffers, which is what's happening. So the fact that the ten year and the thirty year really moved makes it so much more difficult for ratral Reeves, especially in a week where there's so many bond auctions. Why the UK does she need to now just find extra money.
At the moment she does. I mean markets are fickle. It could all move back. And obviously, you know, we did have a big move in just the days after the budget. Actually, in fact, her entire headroom was wiped out within about three or four days, and then the markets came back in and readjusted again and she had much of her headroom was restored. And now they're going back again the other way and they've taken away even more. So she's now effectively indeficite. She has made it very
clear that her fiscal rules are non negotiable. They're her iron clad fiscal rules. So she is going to have to on March the twenty sixth, if nothing else changes, when the fiscal update is presented by the OBI, she is going to have to have shown that she is repairing to some degree or replenishing the full ten billion of headroom she had, and that will require tax rises, it will require spending cuts, could require well welfare cuts as well, but she's going to have to do something.
At the moment, they're sort of indicating that. You know, there's the spending review coming in June, and there the indication is that they'd rather do it through just trimming spending.
I mean, as you're describing it. Therefore, we're talking about the kind of the buffeting of this government by by the markets. And you've got a story out and your first paragraph you say, six months into her job, her project is close to.
Being in tatters. How did it go so wrong so quickly?
You know, they talk so much in the election campaign about stability, fixing the foundation of the economy.
Is it external shocks here? Is it?
What's going on globally or is the blame really to be do we need to point the thing a really at her and her policies.
I mean, there's a bit of both. But the I mean, the reason why that the project is, you know, in deep trouble is because the entire project is based on growth, generating the returns that will deliver the public finance, the improvement in public finances so that you know, you know, basically the debt coming under control. Also all of the money for public services. I mean, she did forty billion of tax rises, which was you know, the fundamental way
in which we fixed the public services. That's the goal.
But then.
Because of the manifesto pledges that you couldn't just do broad based tax rises, she's had to effectively put it all on business employer, you know, through the payroll tax, which is then causing uncertainty and problems for business about how that then comes through the pipe. Will it come through in higher prices so it consumers like to pay more and that's inflationary. Will it come through in squeezing wages?
I mean, there was these there's been a combination of sort of missteps because it's not clear exactly why, but obviously they were trapped set by the Tory Party during the election and then and then subsequent decisions that were made. But you know, ultimately, if she doesn't get the growth, it's going to be very difficult to fix the public services and all the pledges she's made on not putting taxes on working people, you know, that may have to
be broken in the worst case scenario. And so the project does begin to look like it's can unravel.
And I think it's it's a good reminder that the UK is a small, open economy and I think Mark Carney had said, you know, it relies on the kindness of strangers. This is an economy that's extremely dependent because of the amount of debt on foreign buyers of guilt.
It's not just the debt actually, it's also that we have a we have a current account deficit to our trade position, so just paying to pay our way in the world, we require, you know, a lot of money from foreign foreign, foreign investors into the UK.
So we've got this.
I mean, in economics they call it, they talk about the twin deficit of the budget deficit and the current account deficits. So the government cannot find it itself without the kind of strange kindness of strangers that those overseas investors, and you know, just in general, like business and the way that the economy operates, it also needs that money
from foreign investment as well. So if we if we spook those foreign of us, does they either will take their money away or they'll say we want to beat which we want to charge us a bit of a premium. And that's what's happening now because that's why we're seeing those borrowing costs going up.
What's also struck me this week, FIRL is it is kind of what's going on in the real economy. We've had trading updates from some of the big bell Weather retailers talking about Christmas, you know, and it's this contrast because a lot of them have said, haven't they looked that we had not a bad performance next Mark Suspenser's sales up, But then they've thought they've had these very
gloomy outlooks. They said, look, we're being piled on with extra costs from wages from the National insurance hike, uncertainty in the future, and that has caused the share prices to take to take fright a bit. So it is underneath the hood of the economy. There's a lot of trepidation from business and is that feeding through to people thinking, well, growth is going to be really challenging, and that makes Rachel Reeves's whole project much harder to achieve.
Yeah, there's there's definitely a sentiment as she going on in the business world. I mean, in a way, I do look back to sort of post Brexit, where there was absolute ridiculous level of uncertainty, and you know, we've got a very small fraction of that level of uncertainty coursed by all these Knix rises in the national living wage going up, and obviously what happened is that business learned to live with that uncertainty, and this will be
much easier to learn to live with than Brexit. So I'm a bit cautious about the amount of damage that all this will ultimately do to the growth potential, but certainly businesses are saying that they're worried, and that's it's and it's not helping sentiment. So labor does have a growth strategy, which is this big investment plan and basically the reform agenda to get planning obstacles removed. Probably with
that it's a sort of temporal issue. You've got in the short term, you've got all these tax rises coming through, which will inevitably have some kind of dampening effect on growth, But then the investment comes through later, so you can then get the growth later on. And so the Office of Budget Responsibility is forecasting more optimistic growth trajectory in the back towards the back end of the forecast. But in the short term we're obviously facing this particular conundrum.
And so people, i mean markets are looking at the immediate what's happening immediately, and you know, the budget forecasters are looking what's happening what's longer term, And obviously the government is trying to think has always been trying to think longer term. It's a question of whether they can get to that longer term thing without being completely disrupted by the market moves.
It Phil is as soon as you have, you know, big market moves and the market it's also almost a self fulfilling prophecy, right, And I know you wrote about the fact that you have these big move in borrowing costs in guilds but also pound and so you just have to make sure that investors don't completely lose faith. There's been a lot written about the speed of the moves and the fact that it was a little bit like the Loose Trust mini budget and that was like
a horror show. Is the market much better placed now in terms of being strengthened since that budget or is it more like the nineteen seventies deck crisis.
Well, Martin Wheel's the former Bank of England rate center who's drawn this nineteen seventy six analogy when the UK went to the IMF for a three point nine billion dollar loan. Obviously, the issue here is whether you know markets aren't going to basically just turn against the UK entirely. I mean, I'd be cautious to say either scenario is the outlook at the moment, because we had huge short term movements and they and they kind of catalyzed into
massive catastrophes through the LDI crisis that we had. We're having smaller moves now. It's kind of orderly, I mean, as what I think at Deutsche Bank, ever, nota the foreign exchange desks suggested or they were saying that in a way, the fact that this is not an acute crisis like liz Trust, it is kind of worse because it's actually saying people are genuinely worried about some of
the under underlying dynamics in the UK economy. But it does mean, it does mean that you can get this kind of chronic picture for you know, the UK trajectory, which can which which can then become a dominant narrative. But that's not as dangerous in terms of immediate risks as a kind of complete acute catastrophe overnight, which can absolutely as we saw in twenty twenty two, you know, destroy a premiership.
Yeah, in some ways, are we still kind of living I mean, you know, after Chison I took over and Jeremy Hunt, they talked a lot about repairing the damage to Britain's reputation internationally from the trust to backle and you know what was it called the Moron premium on not UK bonds and all that, and that seems to have worked. But is the revival of these questions. Are we still kind of seeing the legacy of that, shaking of the foundational belief that Britain is a good place to invest.
At the moment, you can't help but think that, right, I mean, the UK has historically been a safe Haven and suddenly you have that trust situation where you know, we can mess things up so badly that it causes a massive market panic, and you know, for a brief period, you know, George Osborne in twenty ten used to say, We've got to worry about our you know, our sovereign position because we you know, there's a Greek debt crisis
and we could be like Greece. And it always seemed like a lot of nonsense and a lot of politics, and suddenly, you know, for a brief two week period, we kind of did look a little bit like Greece, and so that might have changed people's the way people view the UK. So I don't think it definitely don't think it has helped the problem with labor is that labor is always you know, starting off on the back foot with markets, and financial markets will be less sympathetic
to policies that they undertake. So should the Tories have done exactly the same thing, it could be pretty sure that they would not be getting as sharp a backlashes as labor are just because of the history. Really, so it does make it just does make life a little bit more difficult for us and co.
So feel going forward because of the market moves. Basically this week, it basically wiped out the spending buffer of around nine point nine billion pounds that Rachel Reeves has. Does it I mean if it continues, you she'll have to find extra money. Do we have an emergency budget budget? Is it too soon to say? And if we do have something that she needs to do quickly. She's ruled out tax hikes, so does she just have to cut spending?
Yeah, So that in the moment they're doing the spending review conversation, So the departments are seeing Darren Jones at
the Treasury. He's the chief secretary who helps set their budgets, and the message effectively is that the spending envelope which was set in the October budget cannot go higher, but it certainly can be smaller, and if they need to find a few billion quit, they can just basically trim it from the sort of you know, I think it's about seven hundred billion pounds of departmental spending and your departmental spending, so you know, in that scheme of things,
it's not an awful lot of money. Personally, I would I would not be surprised if we see some fiddling of the aid budget, which has already dropped from two point seven to zero point five. And they obviously need to increase defense spending, so you know, they can some I don't know if they can change the accounting treatments and move more of it, you know, just move money
out out of aid into defense. But they'll be looking for painless ways of doing this because one of the problems that you hear from you know, investors is that in a market financial market investors, is that there is a there was potentially a credibility problem if they just try and cut departmental spending, because that was exactly the fiscal fiction that nobody, nobody believed that the spending trajectories from the March budget. When Hunt did his final budget
for the Tories, no one believed those spending trajectories. And that's what Labor had to fix, and that's what the forty billion pounds of tax risers was for. If you go back, if she pushes back and says, actually, now we're going to do We're going to cut those budgets from where we've put them in October, the markets may just think this is nonsense. You know, it's another physcical fiction,
wer credibility. We're not gonna that's not gonna wash, and we're going to still turn against you because what you're doing is trying to trick us. And I think, you know, we've got to this point where you just can't trick the markets any any longer. They're kind of they've reached the end of the tether.
Yeah, we'd say, obviously we've heard some you know, attempts to calm the markets, and you know, the Chief Treasury is saying that, you know, the market moves are all in all this stuff. But on the politics of this as well. The chance has gone off to China, hasn't she on a on a trip, and some discussion about whether that was the right thing to do.
I I hesitate a.
Little bit of I'm going to say anyway about remembering Kusa Quat and going off to Washington at the height of the trust to AKM. Of course, on his way back he didn't have a job. I don't think. I'm assuming you don't think we're quite there yet. But you know, is it wise the chance to fly to the other side of the world when the markets are convulsing like this?
I mean, I don't think it's I don't think I don't think it's a problem. It's because it's not acute. It's because it's not like trusts. I don't think it's comparable. I mean, actually that that nineteen seventy six analogy is it's similar because Dennis Healy was on his way to Washington, he was the chancellor in nineteen seventy six, and he had to turn around at the airport and head back to the Labor Party conference at the time and tell them that they're going have to tighten their belts.
But the.
Yeah, I think she should go to China and she should be looking, you know, they should be looking beyond this because this is this is something which can be addressed in coming days. Obviously, you know, on Monday, if the market's convulsed massively, she should be back in time to deal with that.
But you know it's I mean, just come back to your story field. You know, the project is close to being in tatus. If it becomes to be in tatus, can she can our first female chance to eight hundred years, survive in this job much longer?
Has she become a victims.
It's a good question. One question I've been asking myself if everything I mean, if the markets go app to turn absolutely violently against them and they have to rip up their manifesto commitment and actually start raising taxes. I mean, this is an extreme scenario which I don't think anybody thinks is going to happen, but it should that happen. Would she would she would? She be the sacrificial lamb again? Yeah,
I don't know. You look back to nineteen seventy six Dennis Healy, he survived as chancellor for another three years. Labour doesn't have a track record of chopping and changing like the Tories do with their leaders. You know several know how many chancells it was, But I mean who's and who's there? Who would who would replace her? I mean, if Cooper might be a reasonable choice, I mean the others. I mean Analyst Dodds was ke Salmer's first choice for
Chancellor in opposition, but he replaced her. You know Ed mullad Band Obviously he's a former Labor leader, so he potentially could do it. But you know, it's not clear that there's anyone better than racial Roaths.
Bill.
Thank you so much, Thanks very much, thanks for.
Listening to this SPONUS edition of the In the City podcast from Bloomberg. It was hosted by me front Sine Lackwell with Dave Merritt, produced by Somersaudi production support from Moses and Em and sound designed by Blake Maples. Special thanks to Phil Aldrich. Please subscribe, rate, and review wherever you listen to podcasts.