Gilt market vibes are a poor guide to policy

Newspapers and financial markets are equally known for herd-like behaviour, likely to fixate on a single topic and, through that fixation, force it onto everyone else’s agenda. 

So it is with the yield on UK government bonds, more popularly known as “gilts”, and a good approximation for the UK government’s cost of borrowing. In the past fortnight longer-dated yields have risen to levels not seen since 2008; at the 20-year maturity they stand at 5.3%, having traded below 4.5% as recently as September. The last time people paid so much attention to these financial instruments, Liz Truss was the prime minister, and soaring yields were a straightforward expression of markets’ lack of confidence in her policy. 

With the government issuing between £70bn and £170bn of gilts every year, there is no denying that this matters. Taken in isolation, the impact of higher borrowing costs could erode entirely what little fiscal headroom chancellor Rachel Reeves had left after delivering her budget in October. It is quite possible that these market movements will have an impact on Treasury decisions in the months ahead. 

But commentators are too keen to translate these movements into a simple and negative commentary on UK economic policy. The big risk is that policy makers see it similarly and as a result are goaded into short-sighted and reactive policy.

A month of gilt movements aren’t a guide to long-term economic potential 

First, most market-watchers would say the past few weeks mostly reflect considerations beyond the UK, in particular rising US bond yields. These in turn reflect a likely economic and fiscal expansion under the incoming Trump administration. No financial instrument exists in isolation but is weighed and traded in light of what related markets are doing. The spread between US and UK yields has widened a little (perhaps 0.2 percentage points), but most of what has happened has been a rise across the board, affecting sovereign borrowers in the US and Europe too. 

Moreover, while higher yields undoubtedly impose a drag on the Exchequer, it is too soon to draw conclusions about the ultimate effect on fiscal projections. When higher interest rates stem from better expected growth, the positive effect from stronger revenues will weigh on the other side of the balance. Stronger growth may feel unlikely, after a couple of months’ weak GDP figures. But one must recall that the budget last October presaged a fiscal expansion, with the money flowing into public services and investment more than outweighing the contractionary effects of some higher taxes. 

And even if the UK goes through a soft spell, it is important to note that the Office for Budget Responsibility will usually forecast enough expansion to close the gap that has opened up. What matters is its verdict of the UK’s economic potential in around five years’ time. A month’s adverse gilt movements mean little for this.

Vibes-based policy making plays into the worst instincts of government

Rachel Reeves is still operating on an economy that is fundamentally the one left by her predecessors. The flow of new policies is still dwarfed by the stock of what is already there, and what decisions she has made (a widely criticised rise in Employer National Insurance, a more welcome increase in investment) are yet even to be implemented. At this early stage, to blame her and the government for oscillating gilt prices is to place an implausibly large weight on the role sentiment plays in determining economic destiny. 

This is where much criticism has concentrated since October’s budget: the contention is that the combination of an unpopular tax rise with other anti-business measures (an Employment Bill, a rush towards decarbonising the power sector) has met a vacuum where a strategy for growth is meant to stand. This has left business demoralised, disinclined to invest, debating whether to raise prices or put off hiring to compensate for a tax they have not even yet needed to pay. In today’s argot, the problem is the ‘vibes’. 

Vibes are both flimsy and undeniable. Storms from markets and business can arise suddenly, and to those in the centre of government can feel like the most pertinent and timely “data” available (at a time when a lot of economic data is suffering from low response rates and delay). The problem with vibes-based policy making is that it plays into the worst instincts of a government: the part that reacts energetically to bad headlines, that prioritises the dramatic, political response over a considered one. It awakens the crisis-management side of the Treasury, and the comms-led instincts of the centre that demand instant solutions to change the narrative. A few excoriating pieces in the press, and next week there are private secretary notes winging around Whitehall asking for everyone’s six best ideas for growth, regulators are “hauled in” to be told to be more in favour of it, and the government spinners are sent out to reassure political editors that all efforts are being redoubled. 

This is a terrible way to deliver on a strategy for growth, let alone one that uses stability as such a watchword. If the government didn’t have such a strategy before, a week of panicky politically-driven action is not going to generate one. Melodramatic worries about the UK being in a downward spiral can lead to overreaction, such as calls to put everything into artificial intelligence (or house building, net zero, or whatever other single-issue fixation grabs attention). 

Rachel Reeves is facing a test of her resolve

Instead, the government should first make a virtue of not overreacting to these market moves; while crisis-response flexibility is sometimes called for, this isn’t the onset of a war, financial crisis or pandemic. It can offer policy making stability only if it has a thicker hide. Second, if efforts need to be redoubled, they should be on the boring business of generating a proper growth strategy: a robust and widely-understood diagnosis for why the UK has failed to reach its potential, a theory of change explaining how it aims to close the gaps, and policies that generate progress towards doing so. The government’s Industrial Strategy is a good start – it should not allow tremors in the bond markets to rush or derail the good work being done. 

Third, it is quite possible that heavier borrowing costs will indeed require tougher measures to bring about the balance Rachel Reeves has promised. This will be difficult. But it makes it more difficult when too much of the policy debate is conducted in public, as if a continuous public commentary on fiscal policy somehow calms market nerves. A little more focus on getting the decisions right, and less concern with the commentary, is a course worth trying instead. 

Economic and fiscal forecasts frequently move around. As the IfG has pointed out, one problem in the past has been UK governments responding too much to every forecast change – fine-tuning fiscal policy every six months in response to each forecast change to maintain wafer-thin headroom against fiscal rules. This is a terrible way to make long-term policy. It is why Reeves made two important announcements last autumn: committing to hold only one fiscal event each year, and to target a range (not a point target) for government borrowing. Both are meant to insulate ministers from feeling pressure to respond every time the forecast changes, although the range target will not come into effect until 2026/27. 

The current circumstances are an important test of Reeves’s resolve: she should stay the course and ignore the siren voices to action that lured so many of her predecessors.