Market trouble threatens Labour's economic plans

For the Labour Party under Sir Keir Starmer, economic credibility is paramount. Shadow Chancellor Rachel Reeves has set out clear fiscal rules, such as reducing the ratio of debt to national income by the end of this parliament, and she views adherence to these rules as a key measure of the government's credibility.

Therefore, the recent rise in government borrowing costs poses a potentially huge threat to Reeves, the Treasury, and – arguably – Sir Keir Starmer's entire political project. If the government has to spend more money paying interest on its debt, it will find it much harder to meet the fiscal rules it has set for itself.

Following current trends, March 26th will be a critical date. That is when the independent Office for Budget Responsibility (OBR) will publish its latest forecasts, including an assessment of whether the government is on track to meet its fiscal rules. Assuming the OBR says the government is not on track, which may not happen, there is growing concern about this among senior government figures.

Reeves will be faced with a choice. She previously pledged to only deliver one major tax and spending announcement a year, in the autumn budget. A Treasury spokesperson said last night that "adherence to the fiscal rules is non-negotiable". This suggests that she may have to break that promise and announce, or at least pave the way for, measures to get the government back in line with its rules.

What might this mean? In principle, it could mean tax rises or spending restraints. In practice, given the large hike in employer national insurance rates in October, it will mean spending restraints – a point effectively made by Chief Secretary to the Treasury Darren Jones in the House of Commons today. To be clear, spending restraints do not necessarily mean spending cuts, but simply that spending will grow by less than originally planned.

Economics may soon collide with politics. It is all well and good for the Treasury to take measures to reassure the bond markets that trade in government debt. But just because a strategy makes economic sense does not mean it is politically feasible within a Labour Party made up of MPs who have spent the last 14 years condemning Conservative austerity. Many Labour MPs, including cabinet ministers, believe there is little more that can be cut from the national finances. They were already anxious about a tough multi-year spending review, expected to conclude around June, before the rise in borrowing costs.

There is almost a risk of a paradox: any spending restraint that is significant enough to calm the markets may be too visible and significant to be politically palatable within the Labour Party – particularly after the controversy over the cuts to winter fuel payments for pensioners. Labour figures argue that previous Conservative governments have dealt with similar issues by delaying the most painful spending measures to the end of the five-year forecast period – hoping things will have changed by the year those “scheduled” measures arrive. But there are also fears that, precisely because the Conservatives have done this, repeating the same trick will not be recognised by the markets: the financial sins of the previous government will be visited on the new one.

Unlike the recent Conservative debates about economic policy, Labour has one huge advantage. In 2022, when Liz Truss decided to pursue radical tax cuts, there was no consensus within the Conservative Party about how to handle the economy. The 2022 leadership election that Truss won against Rishi Sunak was essentially a clash of economic ideas. She won that argument among Conservative members, but lost it among the party’s MPs – and then definitively lost it with the public and the markets in 49 days.

Labour, aside from some private debates over tax for the very wealthiest and welfare for the very poorest, is largely united on economics, especially on what the Conservatives got wrong. But what if these shared beliefs about how best to manage the economy turn out to be a product of an era of low interest rates? How do you maintain that consensus if the markets disagree? It is the worst possible political situation for Reeves.

When influential Labour figures were asked this morning about the markets, the response was that markets go up and markets go down, and that markets can change quickly. But everyone acknowledges that it is a bad sign when the value of your currency is falling at the same time as borrowing costs are rising. One government source said to me: “It’s absolutely not time to put on the tin hat.” But everyone is watching developments anxiously.