James Carville, political strategist and former adviser to Bill Clinton, famously said he would want to be reincarnated not as the US president but as the bond market. Then "you can intimidate everybody," he said.
Rachel Reeves is very likely be intimidated by the latest movement in the gilt markets (the markets for UK government bonds). Yesterday, the yield (or interest rates) on 30-year gilts increased to 5.25%, higher than their 4.5% spike after Liz Truss's disastrous mini-Budget in 2022.
The UK's interest rates on long-term borrowing are now at their highest level since 1998. Experts warn that this puts the government on track to miss the main fiscal rule Rachel Reeves set in her maiden Autumn Budget: the borrowing targets. And if the Office for Budget Responsibility (OBR) judges that to be the case, the chancellor will have to make some adjustments.
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After a record-breaking £40 billion tax hike in the Autumn Budget, Reeves "downplayed the prospect of further tax rises", said The Telegraph's economics reporter Melissa Lawford.
But, thanks to the "eye-watering" increase in borrowing costs, the financial markets "may yet force her hand". Economists are "increasingly convinced Reeves will have to raise taxes again", maybe "as soon as the spring".
Higher bond yields are driving up the debt interest bill, to the point where the "slim fiscal headroom" Reeves left herself in October's Budget – about £9.9 billion of leeway – "has already been all but wiped out". It now stands at just £1 billion: a record low in recent history.
Tax hikes are even more likely because of Britain's "dismal growth outlook". In October, the OBR predicted that the UK economy would expand by 2% in 2025. In January, however, Deutsche Bank said it expected the economy to grow by no more than 1.3% this year, after it stagnated during Labour's first three months and flatlined at the end of last year.
Big "revisions" to the OBR's growth forecast are likely, said the investment bank. "As a result, more borrowing and tax rises, we think, will be likely this year," wrote Sanjay Raja, its chief UK economist, in a note to investors. Reeves will "likely need to lift taxes at least one more time".
That would be an "embarrassing climbdown", said CityAM's city editor Charlie Conchie. Reeves did, after all, label the Budget a "once in a parliament reset" – although Keir Starmer later said he could not rule out further tax hikes caused by "unforeseen circumstances".
The City is "gloomy about the outlook", and thinks Reeves will have to "tax, spend and borrow more", said John Rentoul in The Independent.
It is also worrying that Reeves has said that the government's five-year spending review won't take place until June. That feels like "postponing the conclusion of difficult negotiations with spending departments until as late as possible, in the hope that something might turn up".
What next?
The OBR will start the process of updating its growth forecast next month, and it will be presented to parliament in the spring statement on 26 March.
The Treasury has stated that there will be no tax changes in the spring statement. But it is "braced for the possibility" that the OBR will judge Reeves to be in breach of her own fiscal rule, according to Sky News. In this event, Reeves would "be left with no choice other than to shrink public-spending budgets further, as well as look for additional, potentially politically unpopular, cuts to the welfare budget".
This would probably put her "on a collision course" with ministers at the Home Office, and the justice, housing, transport and environment departments. Meeting the fiscal rules is ultimately "non-negotiable", a Treasury spokesperson told The Telegraph, but any further spending cuts are "likely to be greeted with horror by some cabinet teams", said Sky News.
The chancellor will be in China this weekend and then in Davos for the World Economic Forum next month, in a bid to "sell the UK as a stable and productive place for investment", said Rentoul. The news from the gilts market is "a reminder" that, in both Switzerland and China, the "stakes are high". Reeves has "a mountain to climb".
