A year ago economists and the hapless Sunak government were optimistic about the UK economy.
The end of 2023 had been miserable. High energy prices, persistent inflation, staff shortages causing problems everywhere and figures subsequently published would show that there had been a "technical" recession, with two successive quarters of falling GDP.
But by January the most optimistially deluded of the Tories felt that a golden scenario was in prospect: falling inflation leading to lower interest rates and rising real terms wages. Advisers suggested the economy was liked a coiled spring, ready to recover because of a combination of factors, with an outside chance of a victory in an autumn general election.
Now that outside chance was always a long shot and we may never know what on earth was in Rishi Sunak's mind as the wally without a brolly stood in the Downing Street rain calling an early general election. There was supposition that the economic outlook was negative rather than positive - interest rate reductions had been deferred by the Bank and maybe things were going to get worse rather than better.
They didn't actually get worse through the late summer. Inflation dropped to 2% (though it's gone back up a bit since) and growth was much improved at 0.7% in Q1 and 0.4% in Q2. We'll never know whether a November election would have been closer, though one still couldn't imagine anything other than a Labour win. Just like in 1997, when the Tories had delivered 3 good years of an economy was going well, the electorate had long since made up their mind that they didn't want more of the Tories, even if there was nothing like the kind of love for Starmer as for Blair. A couple of good quarters was never going to return Sunak to no 10.
However, at the start of 2025 there is none of the cautious economic optimism of a year ago. Growth was flat in Q3 - it fell in GDP per capita terms. Labour's mission for growth has stalled on the launch pad - indeed there are fears of recession. The cost of government debt (gilts) - the most important indicator of confidence in the government and the thing that sank Liz Truss - ended 2024 at 4.55% but has continued edging upwards and this week reached 5.4% for 30 year gilts, the highest rate since 1998. For context the OBR projected rates 0.4% higher for 5 year gilts by 2030 as a result of the Reeves budget but we've already past that figure. 7% would be getting into Greece bailout territory.
The rate at which the UK can borrow matters because higher debt repayments on our mountain of public debt means higher taxes or less to spend on services. In order to maintain confidence the chancellor pledged to meet the latest version of the Treasury's "golden rules". At the time of her budget she had some £10bn of leeway, a figure the Institute for Government called 'small'. The increase in rates has meant the leeway has disappeared. If rates go higher she would be forced to break her rule, cut services, or raise taxes. Raising taxes would break a promise from just a few weeks ago that the tax rises in her budget were a once in a parliament event and she wouldn't be back for more. Cutting services will go down a storm with the Labour left and result in lots of hand wringing all round. The Institute for Government said it was 'not clear' how Reeves would respond in the event of even a 'modest' revision to forecasts.
In the run up to the budget Mrs H and I commented to each other that Reeves looked as if she wasn't sleeping. We thought she was worried about the decisions in her big bang first budget. She looked even worse in the Commons this week:
There was a lot of crowing in the Daily Mail a few days ago about the situation the economy and Rachel Reeves find themselves in. To be fair, while the budget unsettled markets, this week's problems are more to do with the world economy, in particular the extra debt Trump's administration is likely to take on. It's a simple matter of supply and demand: more demand for borrowing pushes up rates. Lenders will generally see the US as the best risk, leaving other countries scrabbling around - and needing to offer even higher rates - to borrow as much as they want or need.
The bond markets have come to be seen as the primary factor in keeping the tendency of governments to borrow and spend in check, hence the term 'bond vigilantes'. Who are these vigilantes? Mainly everyday financial institutions like pension and investment funds. Your pension fund is highly likely to hold gilts, quite probably from several countries. They have no axe to grind politically and are simply trying to make good returns and manage risk for their investors. They aren't speculators like George Soros, who famously crashed the pound back in 1992. The bond vigilantes have become the ultimate protector of the financial probity of governments.
You can see from the graphic shown in the same Daily Mail article this week that there hasn't been a sudden loss in confidence in the UK. Yes, since Reeves's budget, rates have been similar to those immediately after the kami-Kwazi Truss budget, but not as the result of a spike as happened then, just an inexorable increase as markets adjust to the international situation:
The Mail's gleeful comparisons with Truss-Kwarteng debacle are way off beam. Gilt rates now are higher than then, but the margin over short term interest rates is small, with Bank rate currently 4.75%. In contrast under Truss 30 year gilts, at 4.8%, were a whopping 3% more than the then Bank rate. She pushed the gilt rate up by 2.5 percentage points - doubled it pretty well - and the sterling index (the pound's value against a basket of other currencies) plunged 12%, whereas it has been relatively stable of late and is stronger since summer.
False news in the Mail? Well the facts are right, it's the inference that's clearly incorrect. I'm not sure what the right phrase is for ignorantly - or deliberately - drawing the wrong conclusion. False news doesn't really fit - deception, misrepresentation perhaps? How about hoodwinkery? (Yes of course I just invented that).
So I have some sympathy for Reeves. But not a lot - much of what is happening was entirely predictable. And she did leave herself little wiggle room, when she could have held some comittments back. Like bunging the train drivers a big increase when they're already paid around twice their equivalents in France and nearly three times their equivalents in Spain, for example.
So no golden economic scenario in prospect for her and Starmer. The latter of course is already significantly tarnished in the eyes of the public by the pensioners' winter fuel allowance cut (I expect this story to keep running with the current cold snap) and the rows over freebies for suits, glasses, gig and football tickets.
There are other indicators of economic problems. Not long ago there were a lot more vacancies than unemployed. But now there are only 1.8 people unemployed for every vacancy, almost what it was before the pandemic. The number of vacancies has fallen 29 months in a row. The boss of one employment agency called this a "slow motion car crash" and a sign of impending recession. "When I've seen this before, that's what's happened". And this is before the employer's NI increase kicks in, in April.
What I'm wondering is why on earth Reeves and Starmer thought giving a weak but convalescing economy one of the biggest kicks possible in the budget would do anything other than make businesses pause investment and recruitment plans. With tax already at historically high overall levels her budget was one of the biggest tax raising budgets ever. £40bn of new taxes made it bigger in real terms than Lamont's post ERM crash 1993 budget and much bigger than anything Brown or Osborne did. It also provided for significantly higher borrowing as well, £30bn of it. £70bn a year of extra spending, £40bn of it on day to day services and the rest increased capital investment. Even the Guardian said it was a return to tax and spend on a massive scale, pushing the UK towards European levels of spending.
Which was like giving the economy a huge kick in the nuts while force feeding it a Red Bull sugar and caffeine rush. No wonder it has stumbled around feeling sick.
A lot of attention focussed on how Reeves chose to raise tax, mainly the employers NI increase. Large companies can deal with it. They can generally pass on costs in their prices. The multi-nationals are looking at which country to invest in, have long term plans and can be reluctant to change course abruptly. But the larger part of the economy, small and medium sized businesses, are in a different boat. One can't blame them for pausing while they see how they can get through what will, for many, be a difficult time.
I've always felt Labour is happier dealing with big companies. They have a better understanding of that culture, with unions, collectively bargained pay and economic regulation. In contrast they've always seemed to me to have little or no understanding of why someone would start a business or go through all the hassle and risk of trying to grow it. At their heart they are more comfortable with a socialist collective type of economy. Add your own adjectives, such as sclerotic, perhaps.
I don't actually expect the economy to shrink, at least not significantly, despite Reeves's well aimed but badly thought out kick. For a start, the public spending increases in the budget will increase GDP in the short term. This is why the OBR's budget forecasts showed a bit of a short term increase in growth, followed by it weakening later in the parliament as the spending increases work through and the growth depressing impact of the tax rises is felt. I think it is more likely to stumble on, flatlining. Maybe Ed Balls can reprise his much used but then incorrect gesture from a decade ago, false news at the time. But now there's the danger of inflation remaining stubborn or even going back up a bit, risking the scenario known as stagflation.
Meanwhile in other areas than the economy Labour is already setting out on courses of action which will steadily erode the precious few gains and improvements made under the Tories. The best example of this is education where Bridget Phillipson risks undoing the gains made in education not just under the Tories but the previous Labour governments as well. Somehow education was a notable success for the Tories over the last decade with large improvements in our position in international league tables for literacy, numeracy and science despite significant real terms reductions in funding.
Controverially perhaps I feel much of the credit for this lies with Michael Gove. While that might be a name one hardly dares mention to any current or former teacher, the evidence is clear, though the credit is far from entirely his. The main reason, in my view, is that education has not been a political football since Richard Baker, Thatcher's education secretary in the late 80s, introduced the national curriculum and the "Baker" training days now known as inset days. As an aside, wasn't it astounding that teaching had precious little of what became known as continuing professional development before that? I recall the odd teacher going off for a sabbatical but keeping up to date back then seemed to be entirely ad hoc. From Baker onwards successive Tory and Labour education secretaries have built on their predecessors achievements rather than changing course. Labour introduced academies, now it threatens to water them down. Phillipson, in thrall to the producer part of the process (i.e. in this case teaching unions), has set out on a path which is likely to erode these various achievements as well as being, in what folk had been saying was an out of date phrase but seems to have gained fresh legs, utterly "woke". I'm referring, of course, to decolonising the curriculum (there wasn't much colonialism in what I was taught in the 50s and 60s for God's sake - just teach history, warts and all and keep contentious takes like critical race theory out of it). Though taking the decision to put schools into special measures away from Ofsted and giving it to civil servants probably presents greater danger.
Things have gone quiet on watering down industrial relations legislation (but it will come back) and of course we have the dogmatic pursuit of a net zero electricity grid by 2030 which no genuine expert thinks is any other than 'challenging'. Having had to be told by the US to ditch Huawei from our telecomms system we're now thinking of putting Chinese stuff in key elements of our disaggregated, renewables dominated grid. But don't worry, I expect periods of dunkelflaute (a German word for periods of windless, cloudy days in autumn and winter) are more likely to crash the grid in coming years.*
This scenario, with a limp and unenthusiastic economy, large pay rises buying off strikes with no reform or efficiency strings attached and things that work replaced with what the providers prefer to dish up is broadly what I feared and why I didn't vote for Labour in the last election.
There are grounds for hope that Labour will prove incompetent at delivering damaging change. It's remarkable that so early in Starmer's term as PM he picked up the whinge of previous ineffective PMs and ministers by saying that the levers of power weren't connected to anything and the civil service was getting in the way. The difference this time was he then had to back down after the civil service unions complained. I'm sure the civil service and other elements are obstructive at times, Michael Gove's blob etc. But I've also always thought that ministers don't understand that, in many areas, the civil service is there to formulate policy, not to implement things in practice. Which is why bodies charged with doing that, like the NHS, exist. Those levers in many areas don't connect to anything because they never have.
A few ministers do understand that. Unfortunately, not the right ones. “The only minister who really knows how to work the system and get officials delivering what he wants is Ed Miliband, who has been there before,” a colleague of the climate-crusading energy secretary told Tim Shipman of the Sunday Times**. “And Ed is the one minister we don’t want to be a success if we want to win the next election.”
Some of the above draws on David Smith's column 'The coiled spring economy that failed to bounce back' in the Sunday Times on 29 December 2024, though he didn't quite as directly link it to Reeves's budget or use analogies like a kick in the nuts. The comment on the implication of a long term fall in vacancies also came from the Sunday Times business section. Smith's column this week was called The bond vigilantes are back - and that's no bad thing (12 January). I'd already written my paragraph on their significance by then but his helpful summary of the movement in bond rates meant I didn't have to look them up.
Other sources:
Rachel Reeves' first budget is a clear break from the recent past, The Institute for Government review of the budget, was published on 30 October 2024. Note to their editor: it really should be "Reeves's budget"
Rachel Reeves goes back to the future with a tax and spend budget. The Guardian 30 October 2024
* Wind was our biggest source of generation in 2024, providing over 30% of our electricity. When I worked in energy economics 40 years ago we already knew that wind was the most practicable and economic of the renewables. However we also knew that guaranteed supplies were needed as renewables are intermittent. On some cold days earlier this month wind contributed a tiny fraction of its theoretical capacity, just a few percent of demand. Officials denied we were close to blackouts but there wasn't much resilience for, say, our biggest single source of supply (the interconnector with Norway!) dropping out. A Scandinavian politician had a vivid comment on Germany's energy policy with its over reliance on wind with insufficient base load generation which caused problems across northern Europe recently. He called it 'shit'. I doubt Ed Miliband will take note.
** Politics is notable for party colleagues also being rivals. The delicious and indiscreet quotes from Labour 'colleagues' are from Tim Shipmans's column '2025 will be a political shoot out. Which leader has most to fear?' in the Times on 4 January. This column also explained for me the debacle of the Tory leadership election. James 'not so' Cleverly was favourite to win it until, many believe, some of his supporters tried to fix who would be his opponent in the final run off. Cleverly’s camp think four of his supporters voted tactically for Badenoch, to keep Jenrick out, while Jenrick’s team believe one of theirs voted for Badenoch to keep Cleverly out. Without those votes switching, the run-off would have between Cleverly (42 votes) and Jenrick (40), with Badenoch (38) eliminated. D'oh, they're too incompetent to even frig their own leadership election!