From Miliband and Balls to Osborne: riding our luck in the bond market

If investors really start to scrutinise the non-cuts so far and Britain’s still dreadful fiscal position, bond yields could rise and Britain will see real austerity

Miliband applauds but few others will join in
John Phelan
On 15 November 2011 13:44

String theory posits the possibility of multiple universes exiting at the same time and in the same space. Economically we saw a little of that last week.

In London a few thousand students and professional protestors marched against the government’s plans to make them pay more towards their education.

Meanwhile, in Rome, the Italian government was faced with borrowing rates of over 7 percent. With over €300 million of debt to be rolled over in the coming year these increased borrowing costs threatened to eat up nearly one third of the Italian government’s proposed €60 million cuts. This is catastrophic.

The British government, which was borrowing at rates of just 2 percent, could breathe a sigh of relief. But it was almost very different. In June 2009 UK ten year gilt yields were 3 percent. By February 2010 they had risen to a peak of nearly 4.5 percent.

Gilt yields were moving in tandem with Labour’s opinion poll ratings, the more likely Labour looked to return to power the more panicked investors became.

And why shouldn’t they? As The Guardian revealed, “Civil servants came under increasing pressure from ministers in the dying months of the Labour government to carry out expensive orders that they disagreed with and responded by submitting an unprecedented number of formal protests in the run-up to the general election”.

The Guardian went on: “Such ministerial orders are rare and signify an irresolvable dispute between a minister and his most senior civil servant. Whitehall sources told the Guardian there had been five this year. Public records also show nine last year and five between 2008 and 2005…That marks a big increase on the previous decade. A list of these ministerial directions published in the House of Commons shows that they were issued at a rate of two a year between 1990 and 2005”.

As The Sunday Times put it “One former Labour minister told The Sunday Times: ‘There was collusion between ministers and civil servants to get as many contracts signed off as possible before the election was called…One former adviser to the schools department said there was a deliberate policy of ‘scorched earth…The atmosphere was ‘pull up all the railways, burn the grain stores, leave nothing for the Tories’ he added’”.

The anonymous advisor may have been wrong and instead of poisoning the wells Labour may have been sincerely engaging in a dose of Keynesian fiscal activism. Either way, it was the fast route to an Italian style crisis. And despite the economic vacuities of Eds Miliband and Balls, it still is.

We can see this in the performance of gilt yields since the coalition assumed office and set about restoring some sanity to Britain’s government spending; down from 3.8 percent to 2.2 percent.

There are two possible explanations for this. One is that markets believe the UK is, as George Osborne says, a “safe haven” and have bought the coalition’s tough talk about deficit reduction. Because talk is all it has been. Public spending in April-May 2011 was 4.1 percent higher than in April-May 2010.

By starting the austerity talk in 2009 Osborne has earned a sort of ‘first mover advantage’ over countries in the Eurozone who have been dragged into it kicking and screaming in a desperate attempt to save their currency. Much of Osborne’s cutting has taken place in the minds of investors and for all the fury directed at ‘Con-Dem’ cuts you would rather be a civil servant in Britain than Greece or Italy right now.

A second explanation for the performance of British gilt yields, advanced by the Telegraph’s Jeremy Warner, is that Osborne has been to some extent the unwitting beneficiary of crises elsewhere.

Warner writes that “The (British) budget deficit is bigger and on current projections remains larger for longer than anywhere in the Eurozone bar Greece, while the UK's overall indebtedness – public, private and financial – is amongst the highest in the world, and certainly bigger relative to GDP than anywhere in the Eurozone bar Ireland”

But no matter how bad things might be in Britain, at least we’re not the Eurozone.

Whichever of these interpretations is correct, whether markets have been reassured by his rhetoric or whether he has been lucky that the euro has gone into meltdown, George Osborne’s room for maneuver is limited.

If investors really start to scrutinise the non-cuts so far and Britain’s still dreadful fiscal position, bond yields could rise and, given the damage it would do to the British economy, praying for continued disaster in the Eurozone wouldn’t be much of an idea.  

If bond markets lose faith in George Osborne and the coalition Britain will see real austerity. If that happens those few thousand protestors who demand that the taxpayer teat continues to suckle them might wonder what they were ever complaining about.

John Phelan is a Contributing Editor for The Commentator and a Fellow at the Cobden Centre. He has also written for City AM and Conservative Home and he blogs at The Boy Phelan. Follow him on Twitter at @TheBoyPhelan.

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