Bond vigilantes have the UK in their sights

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The lack of confidence in the British economy has become infectious. From businesses it has now spread to financial markets. Last week investors dumped gilts and sold the pound, as concerns over the UK’s fiscal sustainability mounted. Ten-year government bond yields are near their highest in 16 years. If they do not come back down, chancellor Rachel Reeves’ “ironclad” fiscal rule — to balance the current budget in five years — will be broken. To regain credibility, the Labour government must quickly detail credible plans to raise economic growth and rein in spending.

The recent sell-off in gilts has been triggered by developments in the US. Higher inflation expectations in the world’s largest economy — linked to president-elect Donald Trump’s tariff agenda and strong economic data — have pushed up Treasury yields, the benchmark for global borrowing. This has fuelled concerns over debt sustainability in other economies. But the negative chatter over Britain’s “stagflationary” growth outlook, in the wake of a tax-raising Autumn Budget last October and the limited headroom Reeves left against her fiscal rules, has made the UK a prime target for bond vigilantes.

What can the government do? Unless yields begin to escalate out of control, knee-jerk announcements to cut costs or raise revenues right now could smack of desperation, and maybe even push yields higher. Bond yields ebb and flow, and the current sell-off has not been disorderly. Comparisons with the market panic sparked by former prime minister Liz Truss’s “mini” Budget in September 2022 are wide of the mark.

But doing nothing is not an option either. Trump’s capriciousness means global bond markets will remain fraught. And the message from investors is that their faith in Britain’s ability to cut costs and raise growth in this volatile environment is pretty low. Labour must then flesh-out its economic strategy, rather than speaking vaguely about future efficiency savings and being pro-growth. Businesses and investors want to know how Britain’s prospects will tangibly improve in the near term.

That means the government must double down on efforts to remove barriers to hiring, investment and business expansion. Plans announced on Monday to create AI “growth zones” are a start. But businesses also want to know how touted reforms to the planning system will actually speed-up building processes across the country.

The industrial strategy — planned for the spring — is also an opportunity to galvanise confidence by outlining a pipeline of key infrastructure projects, and ambitious plans to improve access to high-skilled talent. Reeves could sketch out intentions for tax reliefs and simplification ahead of the Autumn Budget, which will be the main fiscal event this year. That could help whet business appetite.

Bond traders will, however, be looking for evidence of near-term improvements to Britain’s fiscal position, too. The chancellor is right to rule out further tax rises, which would be disastrous for confidence. But that means Labour must be prepared to make savings in high-cost, yet politically sensitive, areas such as welfare benefits, the civil service and the triple-lock on pension payments. Indeed, if the fiscal arithmetic does not improve notably, the government could make cuts to feed into the Office for Budget Responsibility’s next forecast on March 26.

Rising bond yields are a wake-up call. Labour should keep calm, and avoid rushed announcements, but it cannot carry on in the slow and fuzzy way it has started. It’s time the government spelt out — with alacrity and detail — its strategy to deliver growth and cut costs.