U.K. faces ominous budget plan dynamics
Add Axios as your preferred source to
see more of our stories on Google.
/2024/10/28/1730159896877.gif?w=3840)
Illustration: Sarah Grillo/Axios
On Wednesday, the British government will roll out a much-anticipated budget plan. Policymakers in the U.S. and around the world may want to pay extra close attention to how things go.
Why it matters: The U.K. wants to make investments that will jumpstart its stagnant economy. But the heavily indebted nation faces a starkly different backdrop from that of the last decade, with more ominous dynamics around debt levels, interest rates and how bond markets react to profligacy.
- It has echoes of issues at play in many major economies, including France right now — and potentially the U.S., in the not-too-distant future.
The big picture: The government is expected to announce Wednesday a raft of spending cuts and some tax increases aimed at shrinking its fiscal deficit.
- But officials previewed last week that these cuts will come alongside a change in fiscal rules that allows the government to borrow money for investments — as much as an additional £50 billion per year (or about $65 billion) by the end of the decade — a move aimed at reversing years of slow growth and low productivity.
It is the equivalent of walking a fiscal tightrope: Nations like the U.K. face pressure to both get their fiscal house in order and spend on green transition, infrastructure and more — without panicking financial markets.
Flashback: Two years ago, newly elevated Prime Minister Liz Truss faced a bond and currency market selloff after proposing budget-busting tax cuts. She backed off, but it still cost her the job and left her with the shortest premiership in British history.
- The new Labour government aims to avoid repeating that mistake through a dance of separating routine spending from long-term investments.
What they're saying: "The real debate in British politics is going to be about whether you're on the side of investment or whether you're on the side of decline," U.K. Chancellor of the Exchequer Rachel Reeves told Axios last week in a briefing with reporters at the British Embassy in Washington, D.C.
- Reeves, who was attending annual meetings of the International Monetary Fund and World Bank, said top economists back such plans: "They are all saying that we've got to free up money for investment."
Between the lines: Reeves emphasized that these investments would provide a "long-term return" for the U.K. economy. "It's not to pay for day-to-day spending, it's not to pay for tax giveaways," Reeves said.
- Reeves did not name Truss. Yet it was a clear signal to investors that this was not Truss-style spending.
The intrigue: U.K. government bond yields rose after Reeves announced the plans to invest.
- The spike was mild relative to the market reaction after the Truss-era budget that was ultimately shelved — though yields on gilts, or U.K. government bonds, are similar now to where they were then, suggesting a persistent high-rate environment that could act as a brake on Labour's plans.
- The 2022 budget crisis "is still fresh in Westminster's institutional memory," economists at ING wrote in a recent note.
The bottom line: The U.K. is the latest to test the delicate balance of economic investment in a way that does not signal fiscal irresponsibility to investors.
- Responding to news that Reeves will shift rules to unlock more borrowing, predecessor Jeremy Hunt said: "The markets are watching."
What's next: The U.S. could face a similar balancing in the years to come. Treasury bond yields have risen over the last six weeks, a sign of investor jitters that a Trump win would translate into a wave of deficit-enlarging tax cuts — at a time when deficits are on track to swell regardless of next week's victor.
