Britain’s recent bond market turmoil has evoked unsettling comparisons not just to the Liz Truss mini-budget debacle of 2022, but, more significantly, to the nation’s crippling debt crisis of the 1970s.
According to a report in Bloomberg, former Bank of England rate-setter Martin Weale points out that the current market conditions could force the Labour government to resort to austerity measures to reassure investors that it will address the UK’s rising debt burden if market confidence doesn’t improve.
This comes as long-term UK borrowing costs have surged, and the pound has plummeted – a combination that signals investors have lost confidence in the government’s ability to manage debt and control inflation.
Sterling plummets as long-term borrowing costs soar
Over the past few days, long-term UK borrowing costs have surged, while the pound has simultaneously fallen – a rare and unsettling combination that signals a loss of investor confidence in the government’s ability to manage national debt and control inflation.
Typically, higher yields would support a currency, but on Thursday, the pound sank below $1.23, its lowest level since November 2023.
Although not as severe as the plunge witnessed in September 2022, when the pound plummeted from nearly $1.17 to below $1.07 in a couple of weeks, this latest struggle has set alarm bells ringing.
However, the UK’s market problems are not entirely unique, coming amid a broader global selloff in bonds.
Echoes of 1976: a “nightmare” scenario
Weale stated that the current events echo the 1976 debt crisis “nightmare” that compelled the government to seek a bailout from the International Monetary Fund (IMF).
The present surge in borrowing costs also threatens to erase Chancellor of the Exchequer Rachel Reeves’ slim £9.9 billion ($12.2 billion) buffer against her budget rules, creating a volatile economic landscape ahead of the official fiscal update scheduled for March 26.
Other economists and investors have attributed the market volatility to skepticism surrounding the Labour government’s promises to fund a large increase in spending through accelerated economic growth.
“We haven’t really seen the toxic combination of a sharp fall in sterling and long-term interest rates going up since 1976. That led to the IMF bailout,” said Weale, now professor of economics at King’s College London, in an interview with Bloomberg.
So far we are not in that position but it must be one of the chancellor’s nightmares.
The 1976 bailout and current economic parallels
Nearly half a century ago, Britain applied to the IMF for a $3.9 billion loan after large budget and trade deficits plunged the country into a severe crisis.
The loan came with stringent IMF-imposed austerity measures.
Today, Britain is once again running twin budget and trade deficits, a situation that has persisted for many years.
On Wednesday, 10-year government yields jumped by as much as 14 basis points to 4.82%, reaching their highest level since August 2008.
The pound fell against all major currencies, slumping by more than 1% against the dollar, while UK stocks also declined, reflecting broad market unease.
UK debt burden under scrutiny
UK government borrowing costs have risen even more rapidly since the start of the year compared to France, which is facing its own political turmoil and has higher public debt.
Although the UK’s debt is lower than the US, France, Italy and Japan, official data shows its debt is approaching 100% of GDP, after a significant jump during the pandemic.
The Office for Budget Responsibility expects the deficit to remain high at 4.5% of output in 2024-25 before gradually declining in the coming years, but at a slower rate than previously anticipated.
Financial market investors said the focus on the UK reflected concerns about how Labour could feasibly deliver its budget plans.
Austerity measures loom as market conditions worsen
Weale said that if current market conditions worsen, Labour would have no option but to cut spending and raise taxes to reassure markets that “the debt was being properly managed.”
Deutsche Bank estimates that the UK’s interest burden in 2029/30 will be £10 billion higher than expected when Reeves delivered her budget, while Dan Hanson from Bloomberg Economics estimates the added cost from rising yields to be about £12 billion.
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