By mid-morning on Wednesday the message had apparently arrived from the markets. Andy Burnham needed to “get real”. The state pension triple lock was under threat. Welfare spending was excessive. Public spending had to be cut. The Telegraph presented the rising yield on British government debt almost as a referendum on Burnham’s first days in Downing Street. Investors had spoken and the government had better listen. Except bond markets do not speak. Prices move, yields rise and fall, traders respond to inflation, interest rates, currencies, expected growth, government borrowing, wars, oil prices and what they think other traders are about to do. Politicians, economists and newspapers then tell us what those movements supposedly mean. That is where economics starts to become politics.
Britain cannot simply ignore its borrowing costs. The yield on the ten-year gilt climbed above 5.2 per cent on Wednesday, while the thirty-year yield approached 5.9 per cent. Sustained higher rates would eventually feed through into the cost of refinancing government debt. The Office for Budget Responsibility estimates that a one percentage point sustained increase in Bank Rate and gilt yields would reduce the current-budget surplus by about £16 billion in 2029-30. That is real money and any government has to account for it. What does not follow from those figures is that pension spending must be the place where the adjustment is made.
Global rises in yields
The story being told about Britain is also a poor description of what actually happened in the markets. Reuters reported on Wednesday that British yields were rising during a global bond sell-off. American Treasury yields have risen. German borrowing costs are at levels not seen for years. Japanese yields have reached levels not seen for decades. The immediate trigger has been the renewed escalation of the US-Iran war, the threat to shipping through the Strait of Hormuz and the resulting rise in oil and gas prices. Brent has been trading around $95 a barrel. Investors fear another inflationary shock and therefore expect central banks to keep interest rates higher.
This tells us what the market movement actually represents. The US attacks Iran. Iran retaliates. Energy prices rise. Inflation expectations rise with them. Investors revise their expectations for interest rates. Government bond prices fall across several major economies and yields rise. British gilts participate in that sell-off. Somewhere between those events and the Telegraph’s morning coverage, the conclusion becomes that pensioners are too expensive.
Jim O’Neill, Burnham’s former economic adviser, supplied the political interpretation. Market pressure, he argued, should force politicians to “get real” about the triple lock and what he called excessive welfare spending. He went further and said Burnham had to make spending cuts. At the same time, O’Neill warned against increasing capital gains tax and opposed a wealth tax. The message supposedly being delivered by the bond market therefore becomes remarkably precise. Pensioners and welfare recipients should absorb the adjustment, while taxing accumulated wealth more heavily would be dangerous. None of that information is contained in a gilt yield. It is a political judgement about who should pay.
Britain’s vulnerabilities
Britain does have vulnerabilities which distinguish it from some other economies. Public debt is high. Growth has been poor. Debt interest already consumes a substantial part of government revenue and years of quantitative easing have left the Treasury unusually exposed to movements in Bank Rate. Burnham cannot announce unlimited permanent spending commitments without considering their effect on inflation, borrowing and sterling. That still does not mean the British state has to refinance nearly £3 trillion of debt at Wednesday morning’s market price, which is another way the discussion becomes distorted. According to the Debt Management Office, the average time to maturity of central government wholesale debt is around 13.4 years, with only a fraction maturing in any individual year. Rising yields increase the cost of new borrowing and the debt that has to be refinanced. They do not instantly apply a 5 per cent interest rate to the entire national debt.
Britain also issues debt in a currency it controls. Sterling floats and the Bank of England is the monopoly issuer of that currency. This is not a magical exemption from economic constraints. Creating money cannot create additional oil, gas, nurses, electricians or houses. Push spending beyond the productive capacity of the economy and the constraint is likely to appear through inflation, the currency or both. But Britain is not a household desperately waiting to discover whether a bank manager will renew its overdraft, however often that metaphor returns to British political debate.
The state does have power
The state’s relationship with the bond market is more complicated than the usual story of governments submitting to external financial discipline suggests. During the crisis following Liz Truss’s 2022 mini-Budget, the Bank of England bought £19.3 billion of long-dated and index-linked gilts to restore orderly market conditions and prevent problems in liability-driven investment funds spreading through the financial system. It later sold the entire portfolio. Financial markets can place enormous pressure on governments, but they are not a sovereign power standing outside the state. When the financial system itself was threatened, the state became the buyer of last resort.
The comparison with Truss also needs handling carefully. In 2022 the government announced large unfunded tax cuts while simultaneously undermining confidence in the fiscal framework. Markets rapidly repriced British assets relative to those elsewhere. What we are seeing this week is substantially a global repricing caused by war, energy and inflation, layered on top of existing concerns about British public finances. Treating the two events as if they were essentially the same encourages the idea that Burnham has already provoked his own mini-Budget crisis when much of the current movement is visible across the developed world.
Burnham therefore has to pay attention to interest costs, inflation and sterling, but that leaves open a wide range of political choices. Spending can be cut, taxes can be raised, different forms of income and wealth can be taxed differently, borrowing can be increased for investment while current expenditure is constrained, fiscal rules can be changed and the composition and maturity of government borrowing can be altered. A government can also try to expand productive capacity so that higher spending does not simply chase a fixed supply of goods and services. Each course has consequences. Each produces winners and losers. None can be derived automatically from the current yield on a ten-year gilt.
A different debate is needed
The triple lock itself deserves a more serious argument than the one being made this week. The OBR estimates that by 2029-30 the triple lock will have added £15.5 billion a year to state pension spending compared with earnings uprating, and over several decades its ratchet effect could substantially increase pension expenditure as a share of GDP. Those figures are a legitimate reason to discuss whether the system remains the best way of protecting pensioner incomes. That discussion ought to involve who receives the state pension, how many pensioners depend upon it, whether poorer pensioners should receive more while richer retirees receive less, how pensions should relate to wages and how an ageing society distributes resources between generations. It is a debate about taxation, wages, housing, wealth and the welfare state, not something that can be settled by pointing at a Bloomberg terminal.
There is a familiar pattern in the way the bond market appears in British politics. Markets are presented as an external force of nature. Governments may believe they have choices, but sooner or later the markets arrive to reveal which of those choices were actually permissible. The verdict has an uncanny tendency to resemble the preferences of people who already wanted lower public spending, weaker welfare provision and lower taxation of capital. The constraint itself is real. The interpretation placed upon it is not neutral.
Higher energy prices make Britain poorer because more of the country’s income has to be exchanged for the same quantity of imported energy. Higher interest rates likewise transfer resources towards creditors and away from borrowers. Government cannot abolish those pressures by pretending they do not exist, but it still decides how they are distributed. An external energy shock can be met by squeezing pensioners, cutting welfare and reducing public services. Taxes on higher incomes, property or accumulated wealth can be increased instead. More borrowing can be accepted for a period, or several measures can be combined. Every choice has a cost, but the existence of a cost does not determine who must bear it.
That is what disappears behind the language of “market confidence”. The bond market tells Burnham something about the price at which the British state can currently borrow, and that price matters. It does not tell him whose living standards should fall to pay it. The answer to that question still belongs to politics. So hold your nerve Prime Minister