Mortgages rates are not rising yet but Reeves has to act

For Chancellor Rachel Reeves, this week has been turbulent. Government borrowing costs have climbed to their highest level in 16 years, and the pound has fallen to a 14-month low against the dollar. She is proceeding with a planned visit to China, while the opposition accuses her of leaving during an economic crisis.

She is also accompanied by the Governor of the Bank of England, Andrew Bailey. The 12-hour flight to Beijing may be the length of meeting she would have hoped to have with him. So, just how serious is the recent market volatility, and what could it lead to?

While markets began to stabilize from Thursday lunchtime, the moves against UK government debt have already been enough to cause problems for the Chancellor's budget. Reeves has pledged not to borrow to fund day-to-day spending and to bring down debt as a proportion of national income by the end of this parliament. The Treasury has said these fiscal rules set out in the budget are "non-negotiable."

Over the past week, UK markets have at times looked rather fragile, with rising government borrowing costs and a falling pound being a key indicator. While the overall direction of markets over the past month has been determined by assessments of the inflationary impact of the trade and economic policies of a potential Trump presidency, the UK has been under additional scrutiny. It finds itself in the unenviable position of facing both US sticky inflation and a stagnant Eurozone.

However, it is important to get the scale of the problem right. The extra cost of servicing the national debt at current rates will amount to billions of pounds a year, enough to require some kind of adjustment to the budget, but not unmanageable, and the clear message this week is that it "will be done."

The impact on budget mathematics is real, but the wider impact that one might expect, rising borrowing costs for companies and households, has not yet materialized. There has not been a spike in fixed-term mortgage rates in the mortgage market, unlike the rapid increases seen during the panic period after the mini-budget of 2022, and there is a curious calm in the markets at present.

One explanation is what hasn't happened. At this time last year, major lenders were aggressively cutting mortgage rates to grab market share ahead of a key point in the house-buying year. That has not happened this year, and that may have an impact on the housing market. The Bank of England has indicated that it will continue to cut interest rates this year. But the markets think there may be far fewer cuts than previously expected, perhaps only one, leaving the base rate at 4.5%.

Many economists think this is a mistake and believe that rates will be cut several times. There is a lot of uncertainty here, and there are divisions within the Bank of England's key committees. The Bank's pronouncements will be closely watched. More positive for the economy is that despite much talk from retailers, many have reported strong results and have not reduced their profit forecasts. Are consumers proving more resilient than expected? Could this drive growth in 2025?

The higher interest payments on servicing the national debt increase the likelihood of the Treasury drawing up adjustment plans based on spending cuts. Cutting £10bn would be painful, but with a majority of 170 in the House of Commons, and a spending review underway, it is achievable. In this context, and with the real threat of a global trade war, it should be noted that Rachel Reeves' new fiscal rules do have an "escape hatch."

If there is an "emergency or a significant negative shock to the economy," the Chancellor can "temporarily suspend the fiscal mandate." While a global trade war might qualify, it would be difficult in presentational terms to suspend a set of "non-negotiable" and "ironclad" rules before they have even really come into effect. These rules are also not yet formally law, and remain "draft" until voted through the House of Commons. Unless there is a very clear economic shock in the coming weeks, this route seems unlikely.

The more important point is that the markets are looking for whether the UK is pursuing a credible set of policies, a convincing overall strategy. After the humiliation of Liz Truss's mini-budget, Labour's pursuit of stability at all costs is understandable. But "stability" is not a growth strategy.

Pursuing green growth through long-term capital investment funded by borrowing is a potential strategy, and one that underpins the US's "Bidenomics." The incoming government has adopted the rhetoric of the US policy under the outgoing president without the same firepower. You might say, "Bidenomics without the money."

But now, with a new Trump administration moving away from that approach, rightly or wrongly, the markets are less convinced that such a strategy can pay for itself. Funding it will cost more and require harsher trade-offs than expected. Bidenomics without the money and without Biden is too thin. A more detailed sustainable growth strategy is needed, and soon.