Chancellor Rachel Reeves faces a critical challenge as internal Labour Party conflicts threaten to undermine her carefully constructed budget strategy just weeks before its scheduled announcement on November 26.
The Perilous Path to Fiscal Credibility
The Treasury had been preparing the ground for what promises to be a tough budget statement, likely to include breaking Labour's manifesto pledges by raising income tax. This drastic measure was intended to build significant headroom against fiscal rules and reassure nervous investors about the government's commitment to repairing the public finances.
Reeves had explicitly told the Guardian last month about her determination to eliminate what markets have termed the moron risk premium on UK government bonds. This premium, coined by Dario Perkins of TS Lombard during Liz Truss's brief premiership three years ago, reflects the additional cost Britain pays to borrow due to political instability concerns.
When Liz Truss and Kwasi Kwarteng delivered their mini-budget three years ago, our bond yields decoupled from other G7 economies and they remain elevated compared with other countries, Reeves stated. I want to bring us back in line.
Market Reactions and Political Turmoil
The chancellor's pre-budget messaging had initially proven successful in calming market nerves. The yield on 10-year gilts had drifted down from above 4.7% in early October to less than 4.4% before the latest wave of speculation about Keir Starmer's leadership emerged.
However, Wednesday's political briefing wars and news of an abortive leadership challenge triggered immediate market concerns. The 10-year gilt yield moved upwards by one basis point, moving in the opposite direction to US Treasury yields that UK markets typically track.
Sanjay Raja of Deutsche Bank observed that today's price action is telling. It's moved off budget to political risk. He added that the market focus is shifting away from the budget and potentially to the price the chancellor and the PM have to pay for this budget.
The Narrow Path Forward
Neil Shearing, chief economist at Capital Economics, emphasised that markets had been expecting substantial measures in the budget, potentially £30-35 billion of tax rises and spending cuts. However, investor attention is now rapidly shifting to Labour's back benches and questions about political stability.
It all becomes, 'how has this landed with the PLP [parliamentary Labour party], is her job safe, is the PM's job safe?' Shearing noted, adding that the government has shot itself in the foot by undermining its own carefully constructed market confidence.
The renewed emphasis on political instability comes at a particularly frustrating time for the Treasury, given that Reeves's pitch-rolling for manifesto-breaking tax increases had appeared successful in calming markets in recent weeks. The budget's success now depends heavily on whether Labour can restore party discipline and market confidence ahead of the crucial November 26 announcement.
