UK Budget 2024: Reeves' Fiscal Challenge Amid Global Economic Concerns

The UK at a Crossroads: A Look at Reeves' Upcoming Budget

UK Chancellor of the Exchequer Reeves is expected to announce the UK's annual budget on November 26th, according to sources familiar with the matter. This event marks a critical juncture for the embattled Labour government as it grapples with mounting economic challenges and immense political pressure.

This significant annual political event is shaping up to be a major test of Reeves' abilities. Economists estimate that Reeves may need to raise taxes or cut spending by as much as £51 billion ($68 billion USD) to fill a 'black hole' in public finances and restore her current less than £10 billion fiscal buffer.

Policy U-turns, such as backtracking on cuts to winter fuel payments for pensioners and scrapping plans to reduce disability benefits, have contributed to the growing shortfall that Reeves must address in public finances. She is also battling higher borrowing costs linked to persistent inflation and concerns about the UK's massive debt pile, as global yields are rising.

A Defining Moment for Labour

After a series of unpopular spending cuts and subsequent policy reversals, leading to a sharp drop in support for the ruling Labour party in opinion polls, the Autumn Budget is widely seen as a defining moment for Starmer and Reeves. Their challenge is to minimize the negative impact on an already disgruntled public and skeptical financial markets, while appeasing anxious MPs within their own party, all while repairing Britain's fragile public finances.

Concurrently, the Office for Budget Responsibility (OBR) is expected to downgrade its estimates for productivity, which will also lead to a downward revision of UK growth forecasts, further complicating the Chancellor's budget calculations.

In tandem with rising UK government bond yields, the pound is also depreciating. This combination of rising bond yields and currency depreciation is generally viewed as a warning sign of fragile investor confidence.

Anticipation in the Markets

In London's financial district, almost no one expects Reeves to rewrite her fiscal rules or abandon Labour's pre-election promises regarding taxation of the 'working class'. She is likely to adopt the International Monetary Fund (IMF) recommendations to conduct only one binding OBR forecast per year, to avoid having to scramble every six months to meet targets based on highly uncertain five-year-out projections.

This will alleviate some pressure on her in the spring of next year, but in the meantime, she is expected to scour for sizable additional revenue sources, and markets are watching closely.

"This is the classic 'you wouldn't want to start from here' situation," said Simon Wells, chief European economist at HSBC. "This will be a just-about-holding-it-together, rule-following budget, which is basically the only thing she can do."

Not a Unique Phenomenon?

Despite gloomy predictions of a 1970s-style budget crisis, market observers are quick to point out that the rise in yields, particularly long-term government bond yields, is not a UK-specific phenomenon.

"There's a lot of hysteria about UK borrowing costs, but if you look at what's happened to UK gilt yields, it's not that different to what's happening in other markets," said Neil Shearing, chief economist at Capital Economics.

On Tuesday, the UK Treasury's Debt Management Office conducted an auction of 10-year government bonds, which saw 10-times oversubscription. While this demonstrates ample demand for UK government debt, its yields were the highest since 2008.

Global Influencing Factors

There are several key reasons for the global upward 'drift' in long-term bond yields, including a severe budget crisis in France, inflation stirrings in Japan, and, most significantly, U.S. President Trump's extraordinary attack on the independence of the Federal Reserve.

Economists generally believe that the Federal Reserve's independence has strengthened its credibility in fighting inflation. The outcome of the legal battle between Trump and Federal Reserve Governor Cook remains unclear, but this ongoing struggle to place the institution under political control seems to have just begun.

In the short term, U.S. interest rates appear to be heading down on the backdrop of what the U.S. president has long asked for, after Fed Chair Powell used his recent speech at the Jackson Hole meeting to signal a shift in stance, pointing to weakness in the U.S. labor market.

But in the longer term, and given Trump's attack on a string of key institutions and his plan to borrow trillions more, investors seem to be getting worried about the credibility of U.S. economic management. These concerns have manifested themselves in a sell-off of long-dated U.S. Treasuries. Gold has also surged to record highs, another potential sign of investor anxiety.

But no matter how global this recent bond market sell-off is, it will only exacerbate the immense pressures that Reeves is already facing.