John Redwood: When it comes to the Bond markets, by her own measures Reeves has ‘crashed the economy’

For one day under Liz Truss as Prime Minister the ten year UK government borrowing rate of interest hit 4.38 per cent. Thirty year money cost 4.8 per cent. The government did not actually borrow at these rates.

The Bank of England changed its policy from selling government bonds to buying  them again and the interest rate subsided as the bonds rose in price in relief.

These longer term rates of interest are settled by the bond market. When the market loses confidence in the government and the Bank, and or fears inflation will rise, bond prices fall as more want to sell than buy. When the markets think the government is controlling the amount of debt sensibly and inflation is under control the price of bonds rises as more want to buy.

The prices of the very long bonds change a lot to change the interest rates. If the government borrowed £100 through  a 1 per cent bond with no repayment date at a price of £100, it would pay the holder £1  of interest every year. If the market then decides the interest rate should go up to 2 per cent because it is concerned  about developments, then that £100 bond can only be sold on to another owner at £50 or half price, so the continuing £1 of interest being paid is then 2 per cent of its new value.

When markets forced up the interest rates in 2022 Rachel Reeves said Liz Truss had crashed the economy. Rachel Reeves  said 4.38 per cent for ten year money was too high and would leave the government paying too much interest. It would also mean dearer mortgages and company loans whose interest levels reflect the government borrowing rates.

So we have to report today in her own words that Rachel Reeves has crashed the economy more seriously and for far longer than Liz Truss did. Today the ten year rate is at 4.95 per cent and the thirty year rate at 5.6 per cent, rates 13-16 per cent higher than 2022.  Indeed the Truss effect was so short lived no lasting damage was done. Rachel Reeves has presided over 10 year and 30 year rates higher than the worst day of Liz Truss for most of the last fifteen months. She has been borrowing large sums at these rates and lumbering future taxpayers with heavy bills to pay the elevated interest charges.

She seems unwilling to accept this, though her own words in 2022 condemn her actions since. She seems unaware of the role she has played in driving down the price of these bonds and therefore driving up the longer term rates of interest. We see the results of her work in last week’s withdrawal of many mortgage offers, as mortgage banks seek to increase the rates they are going to charge borrowers.

There are three main reasons why she has lost control of the bond markets. She has put up public spending and borrowing too much. The market worries about just how much she plans to borrow over this Parliament. It will mean massive new bond issues in excess of what savers are willing to lend at the old prices.

The market is alarmed that she put inflation up from the 2 per cent she inherited to nearly double as a result of allowing large managed price rises for water, energy, rail fares and Council taxes. The  government decided to allow large rises in public sector and utility costs and allowed some of that to be passed on in price rises. Government policy is to import much more of our energy, accelerating the shut down of domestic oil, gas, coal and fossil fuel electricity. The current world energy crisis leaves the UK badly exposed to having to pay ultra high prices for imports in a world of shortages.

The market is also concerned that instead of delivering faster growth as promised the government has slowed our growth almost to a standstill. Higher taxes on jobs, on family farms, on business premises, on producing and using energy have led to many business closures, lost jobs and less activity. As growth slows the state has to borrow more. Tax revenues are less with no growth, and  more people are out of work needing benefits so the government deficit goes up. The state has to issue more bonds to pay the bills.

This leaves the government in a bind. They would like to cushion consumers from the surge in imported energy prices, but do not have the money to do so. They want to reassure the bond markets that the deficit is under good control, but economic developments mean it is not. As consumers pay more for their energy they have to cut back on other things, slowing the economy more. The deficit rises. As the bond market takes fright so interest rates go up. People have to pay more for their mortgages and companies more for their loans. That can cause a further reduction in growth.

There are no good options once the government is in such a doom loop. The best course is to cut out wasteful and less desirable spending before the bond market insists on spending  cuts as it did to past Labour governments in 1975-6 and in 2008-9.

The government needs to set out a growth plan which will work, as its present one is delivering the opposite. It needs to take the cost of living pressures seriously, commencing by getting value for money in the public sector and keeping down state and managed prices.

An easy option is to allow more oil and gas extraction in the UK, easing the need for imports and bringing in large extra tax revenues from products that are very heavily taxed. The investment would also create more well paid jobs. Cancelling the proposed fuel tax rise this autumn and reducing the current tax  rate to allow for the extra VAT coming in as a result of higher fuel prices would also help.

A necessary tougher option is to find ways to restore lost public sector productivity, which has cost us at least £20bn of extra spending for no extra output. Is it so difficult for this government to get us back to 2019 levels of public sector efficiency?

The sooner the government acts the better it will be. We cannot afford current levels of borrowing and cannot afford current levels of interest rates on the new borrowing. The two go together. Controlling spending, boosting growth and raising public sector productivity combine to ease the pressures. Failure to act could end in a bigger bond market sell off and great difficulty in the government borrowing to pay all those spiralling bills.