Mike Newton: The markets will force Labour back into line, or the IMF will

Mike Newton was Conservative parliamentary candidate for Wolverhampton West, and worked for the Bank of England during his career in the financial markets. 

My plan for Saturday afternoon was to lounge on the sofa with our bulldog Albert and watch Celtic and Hearts slug it out, but it was interrupted by a call from a distinguished central banker. He has been a guiding force behind his own country’s financial stability for decades and not a worrier for its own sake. But he was seriously concerned about developments in the gilt and sterling markets.   

On Friday, as markets woke up to the full gravity of the political crisis and a potential Leftist Burnham government, the benchmark ten-year gilt increased by 18bp to its highest level since 2007. The pound was hammered versus every other currency.   

‘What is the right price for gilts now?’ my caller asked. That is a very good question, and the problem for Labour is that no one in the markets seems to really know the answer.   

The implications of that are extremely serious. The post-1970s consensus on fiscal stability has completely broken down and no one knows what is coming next other than much higher volatility. 

The foundations are in very poor shape. What is known professionally as the UK’s ‘fiscal metrics’ (its capability to issue and pay debt) have moved adversely for some time now.   

These include factors such as sovereign debt to GDP ratio (93 per cent of GDP), economic growth (1.4 per cent in 2025 dropping to 0.6 per cent in the first quarter) and the highest weighted average debt maturity in the G7 (fourteen years), which effectively means that when bond markets come under pressure, the UK is hit harder than anywhere else.   

It is also worth noting that 25 per cent of total outstanding debt is linked to inflation (if inflation moves higher this debt becomes more expensive to service). Again, this is the highest in the G7. 

Perhaps none of this would matter if Labour was a centrist government committed to fiscal responsibility, and allowing the private sector to get in with the job of creating wealth and employment. It would also matter a lot less if inflation was low and stable.   

Labour’s policies on employment, energy and regulation have put a structural premium on UK inflation at a time when it is going up globally. The markets have also greatly reduced confidence in the Bank of England to control inflation.   

The value of the pound is perhaps a bit less important than the situation in gilts, but the two are linked as a collapse in the pound would have very serious implications for the cost of borrowing, given its impact on inflation and the value of gilts for foreign investors who ultimately need to repatriate profits (or losses) into their home currency. 

The pound has now started to sell off as global investors internalise the seriousness of the situation, and the implications of the closure of the North Sea to new drilling as announced in the King’s Speech. Sterling has now become a ‘reverse petrocurrency’ at a time when it has never been more important to be one.   

So what happens next? Well markets never travel in a straight line, but the broad direction looks set: higher gilt yields and a weaker pound. But are we heading for a real crisis or just volatility? 

I think crisis: and I sense we are in one now. Labour is going to lurch to the left whatever happens, and Burnham’s lack of respect for the bond market is being imitated now by Streeting, and of course Miliband and Rayner are already fully signed up members of that club.   

Rather than arguing why gilts should yield 6 or 7 per cent, I think it is now more of a case of saying ‘why shouldn’t they? The burden of proof has shifted. 

Burnham’s plans to have a separate class of gilt for defence, infrastructure and the NHS is particularly insane, as the idea that different types of expenditure can be ringfenced has been proven over the years to be a complete non-starter. The markets set a price for debt based on how much there is, not what the proceeds are used for.   

It is frightening ignorance. If it was a workable fix, believe me it would already be done by every government in the world. 

There is no handbrake from Labour’s MPs or grandees for any of this. When Liz Truss made her mistakes, the Tory machine stopped her. The Labour Party is the other way round on this. It actively wants the mistakes to be made! 

Labour blowing up the gilt market will go one of two ways: interest rates on gilts rising to such highs that new issuance becomes so expensive it is unsustainable and reverses course, or it runs the car off the road and must ask for an IMF loan.   

The latter would of course come with very stringent conditions, and given that the US effectively runs the IMF, the terms that the Trump Administration would offer a Socialist Britain would be eyewatering. It might even be the case that the UK Treasury instead asks for help from the European Central Bank and tried to peg sterling to the Euro, which would suit the Rejoiner motivations of Labour’s elite very nicely. 

As Conservatives, we need to have a stringent alternative, and that is to structurally stabilise the public finances through a smaller state. I believe philosophically that government exists primarily to facilitate individual opportunity, and the state should not, and cannot, be involved in our lives to the extent it is. And now it cannot be afforded either.   

Andrew Griffith MP wrote here last week that ‘the solution has to be a Conservative one…built on the hard truth that no government has run a fiscal surplus since 2001.’   

Andrew is dead right. In addition to a radical re-examination of what the state pays for, there needs to be very serious consideration of the introduction of something like the German debt brake (die Schuldenbremse) through legislation, which limits the government’s ability to take unnecessary risks with the public’s money.   

While we continue to rebuild trust under Kemi, we should be mindful that we are going to have to provide clear and hard headed solutions for the problems Labour has created, and the solvency of the country unfortunately looks to be top on the to-do list.