Safety-first budget revives UK’s 1974 question

LONDON, Dec 1 (Reuters Breakingviews) – In February 1974, Edward Heath’s Conservative Party famously launched an election campaign with the question: “Who governs Britain?”. The prime minister offered a choice between his elected government, which was attempting to slay inflation with aggressive labour market reforms, and the mighty UK trade unions, which were resisting the change.

In 2025, British politics once again faces a similar standoff. This time, however, left wing politicians are posing the question, and the targets of their ire are not unions but bond markets.

Zack Polanski, the leader of the UK’s Green Party, summed up, the frustration three days before Rachel Reeves, Britain’s finance minister, unveiled her budget on Wednesday. “What I think we need to do,” he explained, “is get back to a place where actually democratic politicians who are elected by the people are more worried about the cleaners, the teachers, the nurses … rather than the people who hold these assets, who are making money while they sleep.” Andy Burnham, the mayor of Manchester and a rival to Prime Minister Keir Starmer, put it even more bluntly, in September: “We’ve got to get beyond this thing of being in hock to the bond markets.”

The essence of these critiques is that the fiscal rules,Reeves introduced in 2024 to bolster credibility with bond investors induce an unnecessarily conservative bias into her management of the public finances. Left-wing politicians argue that by committing to current budget surpluses, shrinking the public debt ratio, and capping welfare spending, the government is prioritising disinflation over growth and rentiers over workers.

On Wednesday, Reeves brushed off those complaints and came down squarely on the side of the bond markets. Though she expanded welfare spending and introduced fresh subsidies for renewable energy, those giveaways were more than offset by a slew of tax increases which the Office for Budget Responsibility (OBR), forecasts, will lift UK taxes from 35% to 38% of GDP over the next four years – its highest-ever level. As a result, the independent fiscal watchdog projects government borrowing will fall from 4.5% of GDP this year to under 2%, while inflation will cool from the current 3.5% to the Bank of England’s target of 2% by 2027. The OBR projections show Reeves meeting her surplus target a year earlier than required, and enjoying twice as much headroom by 2029 than it forecast in March,

The small print is not so rosy. It rarely is. Reeves can claim she is meeting her current budget surplus rule because the legal test is based on a balance of probabilities. The likelihood the OBR assigns is 59% – the highest number since 2019, but still not much better than a coin toss. And while Reeves’ beefed-up fiscal buffer of 22 billion pounds might sound impressive, it is only 75% of what her predecessors, on average, thought prudent.

British civil servants have historically argued that the only real insurance against unwanted attention from vigilantes in the bond market is for the country’s debt metrics to be below the median of comparable developed countries when a crisis strikes. On that measure the government is far from safety. The OBR concludes that Reeves’ budget will “leave the UK with a debt-to-GDP ratio that is around twice the advanced-economy average and the sixth highest among advanced economies.”

Nevertheless, the budget was pretty much everything bond investors could have wished for. The immediate reaction in the market for UK government debt was resoundingly positive. The yield on benchmark 10-year gilts dropped by 10 basis points on Wednesday to close at 4.42% – the largest one-day rally relative to other major bond markets on the back of a major fiscal event in nearly two decades, according to Deutsche Bank economists. Longer-dated bonds fared even better. The pound strengthened against both the dollar and the euro.

Yet while lower bond yields reduce the government’s borrowing costs, opinion polls matter more to politicians. On that front, the news is not so benign. Reeves’ net favourability rating, currently negative 57%, is worse than her predecessor Kwasi Kwarteng’s score in the aftermath of the disastrous September 2022 mini-budget that led to him being pushed out of office, according to Yougov, The Labour Party’s support has collapsed since it won the general election last year; its two main right-wing challengers, Reform UK and the Conservatives, currently share around half the vote in opinion polls. Meanwhile Polanski enjoys a near-even net favourability with the public and has taken his party from low single digits to nearly a fifth of the vote, even topping Labour in four recent surveys by pollster Find Out Now,

It’s therefore worrying that the government’s own self-professed “number one mission,  of boosting growth was missing from Reeves’ budget. The OBR had already signalled that it would cut forecasts for productivity improvements in line with the UK’s recent dismal performance. Throw in the budget’s contractionary stance and the lack of any significant reforms that might unleash private sector investment, and it’s no surprise that the budget watchdog cut its forecast for UK economic growth over the next four years from an already lacklustre average of 1.8% per year to an anaemic 1.5%.

Labour’s next big political test will come at local elections in May next year. Economically, Reeves’ bond-friendly budget may look like a low-risk option. Politically, however, it is a high-stakes gamble. The left wing will argue that she has killed growth with fiscal conservatism. The right wing will say she has taxed the private sector to death.

If Reeves is lucky, growth will revive without the need for either stimulus or supply-side reform. If she is not, her government may get the same answer as Heath when he asked, “Who governs Britain?” in 1974.

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