But that same event in 2022 has also bound the hands of Starmer’s Government ever since it took over a year ago.
“The Truss-Kwarteng government tested the view that the markets would be willing to finance us whatever we did,” said Nicholas Macpherson, a former permanent secretary to the Treasury who is now in the House of Lords.
Before the pandemic and the global rise in inflation and interest rates – made more chaotic in the UK by the Truss episode – bond traders seemed unworried by high levels of debt, but that has now changed. Macpherson told The i Paper: “The problem Britain has is that the markets seem far less tolerant of large debt that they were, so you really don’t want to be an outlier.”
Rachel Reeves says she is restoring stability to the economy (Photo: Getty Images)
The spike in the Government’s borrowing costs which came in the wake of the mini Budget coincided with a rapid increase in mortgage rates on offer from banks and building societies. Economists believe this was partly because mortgages tend to get more expensive when gilt yields rise – as when lenders can get a higher return from government bonds they will charge more to put their money into home loans. But they think the main reason was the extreme uncertainty created by Truss’s policies.
Fresh tax rises almost inevitable
“We inherited debt of 100 per cent of GDP, and global interest rates are high,” a source close to the Chancellor said. “Having uncontrolled debt means markets lose confidence in your economy.”
The point is emphasised by a Treasury spokesperson, who said: “We’ve seen what happens when the nation’s finances are put at risk – working people pay the price, with higher mortgage and borrowing costs. That is why the fiscal rules are non-negotiable.”
Another recent signal of rising problems in global bond markets has come from Japan. The east Asian power, which has the largest stock of debt as a percentage of GDP of any country in the world, has recently seen a sharp rise in its borrowing costs in a warning sign that investors may be becoming less tolerant of unusually big debt piles.
Donald Trump’s policies could ahve a knock-on effect in the UK (Photo: AP)Independent experts mostly agree. “It’s clear that the UK needs to shrink its primary budget deficit and it will find it hard to do so,” said Ruth Gregory of Capital Economics. “This is exacerbating growing worries about fiscal sustainability.”
Almost certain that ‘headroom has been wiped out’
Caswell said: “Having this very narrow headroom of 9.9 has made people and businesses think, ‘well maybe there are going to be further tax rises in October’… It is almost certain that the 9.9 has been wiped out. She is definitely going to have to raise taxes, the question is which taxes she raises.”
Theo Bertram, who worked in 10 Downing Street under Gordon Brown and is now head of the Social Market Foundation, said that the situation facing Reeves and Sir Keir Starmer is trickier than when Brown and Tony Blair entered power in 1997 – and possibly even more challenging than the global financial crisis.
“There is nothing to come out of those taps, there is no spending to follow – it is nothing like ’97, there is just no money left,” he told The i Paper. “A Labour Chancellor who came in and then turned on the taps, they would just be doing on the left what Liz Truss did on the right.”
Where taxes could rise
Rachel Reeves has limited her options for the next Budget, due in the autumn, thanks to a number of previous promises.
She insists it will not be a repeat of last year’s, which brought billions of pounds in tax rises – but has also vowed she will stick to her fiscal rules even if, as most experts expect, deteriorating economic conditions mean she needs to cut borrowing further.
The Labour manifesto at the last general election said the party would not raise income tax, national insurance, VAT or corporation tax – the four most lucrative forms of taxation for the Exchequer.
That leaves a restricted number of choices on the table: the Chancellor could increase capital gains or inheritance tax, or limit tax relief on pensions, and argue she is keeping her pledge not to target “working people”.
She could also hike taxes on businesses again, as happened at her first Budget, although that would enrage the corporate world and risk pushing unemployment upwards.
One possibility being floated is extending the freeze on income tax thresholds: this increases the tax take but tends not to be experienced as a tax rise by most workers because their overall take-home pay is still going up.
Some of Reeves’s supporters would like her to consider a nuclear option of reversing the cuts to national insurance brought in by Jeremy Hunt, which would be a manifesto breach but could be justified on the grounds her predecessor did not adequately fund his giveaway.
Other than tax rises, the only other way to cut the deficit is to reduce public spending – a move that would be highly unpopular with Labour MPs.
When governments ‘lose control’
Carsten Jung, the head of economic policy at the progressive IPPR think-tank, said a genuine debt crisis was “very unlikely” but added: “The bigger risk is that inflation doesn’t go away, so interest rates stay high and growth is structurally weak. The scare scenario is we are stuck in a slow-growth trap.”
The Treasury spokesman said: “Growth built on strong and secure foundations is the government’s number one mission, but we cannot tax and spend our way to prosperity, which is why the government is pursuing growth based on a strategy of stability, investment, and reform.”
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