The notion that the Government is only held back by an irrational and faint-hearted fear of the bond market is appealing but wrong. It views market power as a choice rather than the outcome of the system we have built. The power of the bond market is not some conspiracy: it is built into the plumbing of the British economy. Until that plumbing is redesigned, no amount of bravado or stiff-necked announcements will change the constraints the Government faces. Thinking otherwise is comforting, but a bit naive.
To understand the grip the markets hold, you must begin with what bonds are. When the Government borrows, it issues a type of bond called ‘gilt-edged securities’ (or ‘gilts’ as you may hear in the media – referring to the debt securities issued by the Bank of England on behalf of His Majesty’s Treasury, whose paper certificates used to have a gilded edge). A gilt is just a promise: lend us money today and we will send you interest every year and repay the full amount in the future. The buyers are pension funds, banks, insurance firms, foreign governments and the rest. These bonds can themselves then be bought and sold in the market. Their value is determined by two things: the market value of the bond and the interest rate you can earn on it (the ‘yield’). The crucial point is that the price the market is willing to pay for these bonds moves constantly with their sense of how stable and responsible the Government looks. If the value of existing bonds falls, the yield they attract has to increase to make them attractive to buyers, which in turn pushes up interest rates on new bonds and government borrowing as a whole.
This is where progressive hope goes to die. Even a hint that the Government might spend or invest at a scale beyond what markets find comfortable is enough to send traders selling. As the price of gilts drops, the cost of borrowing jumps (because, by design, the yield increases) and the Treasury immediately feels the pressure. Billions are swallowed in higher interest payments. A choice is made between abandoning ambitions or raising taxes to calm market nerves. This is not the result of ‘bond vigilantism’ it is just traders making economically rational decisions about where to invest their cash.
Britain is especially vulnerable to this routine humiliation. Roughly a third of our debt is held overseas, resulting in an increased risk of market volatility and vulnerability from shifts in global sentiment. Inflation in Britain is much stickier than it is for our European counterparts and investors assume interest rates will stay higher for longer. That expectation itself becomes another upward pressure on borrowing costs. To make matters worse, the Bank of England has been selling the gilts it bought during the pandemic at precisely the same time that the Treasury has been issuing new ones. Two arms are pulling in opposite directions, flooding the market with debt and further driving up yields. There is surely a middle ground between total independence and outright dependence, where the central bank stays independent yet is still able to coordinate with the Government when the situation requires it.
Rachel Reeves’s fiscal rules pour salt on the wound. With barely any headroom against her own constraints, she is at the mercy of every economic forecast. Because she has boxed herself in on borrowing, she looks like someone governed by market sentiment rather than by the voters. The rules are so tight that even a modest shock looks like a crisis in the making. With fiscal events every few months, the Treasury remains in a permanent crouch.
None of this changes unless the framework itself is rebuilt. The fiscal rules should be rewritten so that investment is judged for its long-term value rather than its short-term impact. The golden rule (only borrow to invest) should remain, but investment should be redefined to include current spending that expands the productive potential of the economy, and the Government’s balance sheet should take account of the future value of the asset being created. Social infrastructure, from housing to skills to childcare provision, is the backbone of growth. The obsession of having debt fall within a five-year window is damaging (debt is not good or bad on its own!). It only matters whether it is affordable and whether it funds things that make the country better off. Debt created by wasting money on inefficient PPE procurement should not be valued the same as debt to build public infrastructure that will generate a long-term return. Public investment should be protected at a steady and serious level and Treasury planning should extend over at least a decade. That is the only way to link investment to the growth it eventually creates.
But there is no credible path to fiscal freedom without a tax system that is fair. National Insurance could be cut and income tax raised to compensate, as the Resolution Foundation suggests. The Chancellor didn’t end up raising income tax levels as was floated a few weeks before the Budget, but a 1p increase on the basic rate would raise £5.3bn more than a 1p increase on the higher rate. These revenue numbers are easy to hide behind, but why not raise the higher rate by more than just 1p to compensate for this gap? It would have been a manifesto-breaking policy but one only affecting a fifth of taxpayers.
Rather than just edging up the basic rate, it makes sense to conduct a much broader principled reform of the tax system. National Insurance, at a lower rate, should be regularised to apply equally to all salary levels and all ages, removing the distortions that privilege older and higher earners. Capital gains and dividend taxes should be aligned more closely with income tax, not because it is politically satisfying but because the current gaps narrow the Government’s room for manoeuvre. Raising council tax for bands G and H would generate revenue but isn’t progressive since the bands are still assessed on property values from the early 1990s. Council tax bands should finally be updated so that it reflects real market values and the intergenerational gains embedded in housing. Gambling firms, which extract significant social costs, are finally pay more – which is welcome. Banks, which now hold far larger volumes of gilts – as the post-QE landscape shifts demand towards the shorter end of the curve – should contribute through a modernised reserves system. All of these would generate significant revenue while reducing unfairness in the system.
The way Britain borrows must also change. For years, we led the world in issuing long-term debt that protected us from short-term swings but this advantage has now been lost. Restoring it would give us some breathing space when markets are edgy. We could also encourage more domestic ownership of national debt. A country that borrows mainly from its own citizens is much harder to scare. Treasury and Bank coordination ought to be repaired so the State stops working against itself in the gilt market. Furthermore, the UK Infrastructure Bank should be turned into something real: a national investment engine with the authority to issue its own bonds and back long-term regional and green development without having to beg the markets for permission every six months.
The real disaster of the last decade is that the Conservatives refused to invest when interest rates were close to zero. Low borrowing costs is a golden opportunity for public spending, and we are paying the price for their complacency. Britain needs a new New Deal. Employers should be incentivised to create better paid jobs with development opportunities through job subsidies and training for NEETS, older, and disabled workers. Many of these jobs could even be tied to the green transition. Getting people back in the workforce gives people hope and incomes, thereby cutting the welfare bill and the need for immigration.
The bond market does not simply reward cuts. It rewards clarity. It rewards governments that know what they are doing and stick to a plan. A government that borrows over the long term, builds a fair tax system, coordinates its institutions and invests consistently will not have to beg for credibility. The bond market is not all-powerful but nor can it just be ignored. Its responses result from incentives based on historic choices and it can be reshaped by better choices. The real question is whether this Government has the heart and the guts to make them.
Reuben Chowdhury-Turner first became a Labour Party member in 2019. He recently graduated with a BSc in Economics from the University of Manchester.