Starmer Gives Full Backing To Reeves

Starmer’s Backing for Reeves Calms Market Turmoil After Welfare U-Turn

A turbulent period in the financial markets saw the UK’s borrowing expenditure stabilise, pulling back from a sharp increase. The spike was prompted by Chancellor Rachel Reeves’s distressed showing in the House of Commons and uncertainty over a major policy reversal. The subsequent intervention by the prime minister, asserting his full support for the chancellor, helped to soothe investor nerves and restore a degree of calm. This episode cast a spotlight on the delicate interplay between political stability, fiscal policy, and market confidence, which remains a critical challenge for the government.

The events unfolded rapidly, beginning with visible distress from the chancellor during Prime Minister’s Questions. This, combined with a significant U-turn on welfare reforms that blew a hole in her financial plans, sparked immediate speculation about her future. The reaction from the bond markets was swift and negative. However, a clear statement of support from Sir Keir Starmer helped to reverse the damaging trend, highlighting the market's preference for stability over chaos.

A Volatile Session in the Markets

Yields for ten-year UK government bonds, a key indicator of borrowing costs, experienced a notable drop to 4.45 per cent. This represented a significant retreat from the closing figure of the prior day, which was 4.61 per cent. The market's reversal came after the prime minister’s declaration that he collaborates in complete alignment with his chancellor, Rachel Reeves. That statement was crucial in calming fears that had begun to circulate among investors.

The pound sterling, which had also suffered a decline during the period of uncertainty, found its footing and stabilized around $1.3646. It is important to note, however, that the currency did not manage to recover all the value it previously shed. This suggests that while the immediate crisis of confidence was averted, some underlying concerns among investors may persist, leaving the pound in a more vulnerable position than before the turmoil began.

The Chancellor's Unsteady Moment

The market volatility was initially ignited by the chancellor’s appearance before the Commons during the Wednesday session. Following the administration's decision to abandon plans for sweeping welfare reforms, Rachel Reeves became visibly emotional during the session of Prime Minister's Questions. Her distress prompted widespread speculation across Westminster and the City of London that her position might be untenable, raising fears of a leadership vacuum at the Treasury and a potential loss of fiscal discipline.

This uncertainty was the primary catalyst for the surge in government borrowing costs. A spokesperson for the Treasury later provided a reason for the chancellor's state, attributing it to a 'private issue' and attempting to detach it from the political pressures of the day. However, the timing of the incident, coming so soon after a major policy climbdown, meant that political and personal narratives became deeply intertwined in the eyes of many observers and market participants.

Prime Minister Restores Order

In a decisive move to quell the rising market anxiety, Sir Keir Starmer provided his unequivocal backing for his chancellor. That Wednesday evening, he spoke with Nick Robinson on BBC Radio 4's 'Political Thinking', stating that he and Reeves collaborate in perfect harmony. He asserted that she performs her duties as chancellor exceptionally well, a statement clearly designed to project an image of unity and stability at the heart of government.

This intervention proved critical. By confirming the chancellor's position was safe, the prime minister directly addressed the fears that had driven the spike in borrowing expenses. The message to investors was clear: the government's economic leadership was not in question, and the dedication to fiscal responsibility remained firm. This public show of support was instrumental in causing bond yields to retreat the following day, demonstrating the direct impact of political signalling on financial market behaviour.

Analysts Weigh In on Market Fears

Financial experts observed that the market's reaction was a clear vote of confidence in the chancellor, born out of fear of the alternative. Speaking to the BBC, one analyst suggested that financial markets appeared to be lending their support to Rachel Reeves, worried that her potential departure would severely diminish the government's control over its finances. The core concern was that any successor might lack her dedication to fiscal restraint, leading to more reckless spending and borrowing.

A stark analysis came from Will Walker Arnott, head of private clients for the Charles Stanley bank, during an appearance on the BBC's Today programme. He described the situation as a rare instance where market forces were actively bolstering a politician’s career prospects. Arnott explained that investors are deeply concerned that should the chancellor depart, any form of fiscal restraint would cease to exist, resulting in significantly larger and more dangerous budget deficits.

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A Warning of Lingering Risk

Despite the recovery, prominent economist Mohamed El-Erian cautioned that market tension would likely persist. El-Erian, who presides over Queens' College, Cambridge, and is also the top economic adviser for Allianz, warned that once you inject a risk factor into the financial environment, removing it becomes an extremely challenging task. He expressed on the Today programme a sentiment of cautious optimism mixed with realism.

He suggested a degree of moderation was possible, though he did not anticipate a full return to the circumstances of the previous 24 hours. This expert opinion underscores the lasting impact of such political shocks; even when the immediate crisis passes, a residue of uncertainty can remain, making investors more sensitive to future instability.

The Specter of the Mini-Budget

The recent market fluctuations brought back memories of the financial turmoil that followed the fiscal announcement made during Liz Truss's short-lived premiership. That event, characterised by massive unfunded tax cuts, sent shockwaves through the UK economy, causing a dramatic spike in government borrowing costs and roiling the home loan sector. The 2022 crisis served as a stark lesson in how quickly market confidence can evaporate when fiscal credibility is questioned.

While the recent episode was far less severe, the comparisons were immediate. The sharp, albeit brief, increase regarding bond yields served as a reminder of the UK's vulnerability to shifts in investor sentiment. The key difference this time was the perceived source of the risk. Whereas the mini-budget was a crisis of policy, the recent turbulence was a crisis of political stability, demonstrating that markets crave predictability in both the government’s plans and its personnel.

The Impact on Household Mortgages

Abrupt shifts regarding bond yields are not just an abstract concern for the Treasury; they have a direct effect on the finances of ordinary individuals, particularly homeowners. One of the most significant channels is the home loan sector. Higher yields on bonds can swiftly translate into more expensive mortgage deals, affecting both new buyers and those looking to remortgage. This connection makes gilt market stability a kitchen-table issue for millions.

Lenders use financial instruments called "swap rates" when setting prices for new fixed-rate mortgage deals. These swap rates are heavily influenced by government bond yields, especially those for two- and five-year gilts, which align with common fixed-term mortgage periods. When gilt yields rise, swap rates tend to follow, increasing the cost for lenders to offer fixed-rate products. They often pass this increased cost directly on to borrowers in the form of higher interest rates.

Mortgage Market's Current State

In the period leading up to this recent bout of volatility, the home loan sector had been comparatively stable. Lenders had been engaged in healthy competition for customers, leading to some rather minor but welcome cuts in mortgage rates. This environment offered a degree of relief to homebuyers who had been contending with elevated borrowing costs over the past few years. The stability reflected a market that had found a tentative equilibrium after previous economic shocks.

This backdrop of calm made the sudden spike in gilt yields particularly concerning. It threatened to disrupt the competitive dynamic among lenders and reverse the trend of modest rate reductions. Had the political uncertainty persisted, it is highly likely that lenders would have quickly withdrawn their most competitive offers and repriced their mortgage products upwards to account for the increased cost of funds, bringing an abrupt end to the period of stability.

The £5 Billion Budget Hole

The political and market drama was rooted in a significant policy reversal. The government was forced to climb down on its plans to generate savings in the billions of pounds by overhauling the welfare system. This U-turn leaves an estimated £5 billion funding gap within the financial projections established by Reeves, creating a major fiscal headache that requires difficult solutions. The reversal came after a substantial backbench rebellion threatened to defeat the measures within the Commons.

The original plan involved tightening eligibility for Personal Independence Payments (PIP) and altering the health-related component of Universal Credit to save money. However, faced with intense opposition from within her own party and from disability charities, the government abandoned the most controversial elements. This capitulation not only represented a political defeat but also dismantled a key pillar of the chancellor's strategy to balance the books, forcing her back to the drawing board.

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Difficult Choices for the Chancellor

With a £5 billion gap to fill, the chancellor now faces an array of unpalatable options. To adhere to her own strict fiscal rules, she must find the money from somewhere. The three main avenues are raising taxes, implementing spending cuts in other areas, or releasing more state debt to cover the shortfall. Each of these paths comes with its own significant political and economic challenges, leaving the government in a constrained position.

Jane Foley, who is Rabobank's lead for FX strategy, described the situation as the government being "boxed in." She noted that the gutting of the bill regarding welfare makes the chancellor's position more challenging, since the savings she had planned on would not materialize. Consequently, any choice Reeves makes is likely to face strong opposition from different quarters, whether from taxpayers, public service users, or the very financial markets she seeks to reassure.

The Chancellor's Public Response

Speaking on Thursday with the BBC, Reeves addressed the situation directly. She acknowledged she was distressed during the PMQs session, yet attributed it to a private issue she was unwilling to detail publicly. Shifting to the fiscal challenge, she responded that the adjustments to welfare approved by Parliament this week certainly carry a cost, which the Budget will account for.

Crucially, the chancellor took the opportunity to restate her firm belief in her own fiscal principles. She described these principles by asserting that they will be maintained because they are absolutely essential to the living standards of the workforce and for the operational expenses companies face. This statement was a clear attempt to restore confidence, signalling to the markets that despite the setback on welfare reform, her core commitment to sound financial management and fiscal discipline remained unchanged.

Understanding the Fiscal Rules

The chancellor's "fiscal rules" are the self-imposed constraints designed to ensure the stability of the UK's public finances. A central rule is that daily expenditures must be covered by government income, which consists mostly of taxes. This means that borrowing is designated solely for investment in things like infrastructure and technology, which are intended to boost future economic growth.

Another key rule requires that the UK's national debt must be on a path to fall as a share of the economy (GDP) by the fifth year of the forecast period. These rules are designed to prevent government debt from spiralling out of control and to provide an anchor of credibility for investors who lend the government money. By repeatedly vowing to stick to them, Reeves aims to differentiate her approach from past fiscal indiscipline.

The Market's Trust in Reeves

The market's panicked reaction to the possibility of the chancellor's departure underscores the credibility she has built within the investment world. Investors see her as a guarantor of fiscal discipline. As Jane Foley of Rabobank pointed out, while the welfare U-turn complicates the chancellor's task, investors place enormous value on political stability. The fear of the unknown played a significant role in the market's behaviour.

Foley explained that Rachel Reeves has shown she grasps the significance of preserving fiscal responsibility. It remains uncertain who might succeed her if she were to leave her post, nor is it certain that a successor would command the same level of trust among investors. Therefore, Sir Keir Starmer’s public demonstration of confidence in his chancellor gave the market some measure of reassurance, as it prioritises predictability above all else.

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A Fragile Political Landscape

The entire episode highlights the fragile nature of the current political and economic landscape. The government's need to navigate difficult financial realities is compounded by a restive parliamentary party. The significant rebellion over welfare reform shows that the prime minister cannot take the support of his backbenchers for granted, especially on contentious issues that strike at the heart of the party's values. This internal pressure limits the government's room for manoeuvre.

This political fragility has direct economic consequences. As seen this week, any sign of instability at the top of government can trigger adverse market reactions, increasing the expense of borrowing and potentially impacting everything from public services to household mortgage rates. The government must therefore perform a constant balancing act: maintaining party unity while also adhering to fiscal plans that satisfy international investors and credit rating agencies.

The Pound's Precarious Position

The performance of the pound sterling during the turmoil offers another lens through which to view the situation. While it stabilised after the intervention from the prime minister, its failure to fully recover its losses is telling. It suggests that while the immediate political risk may have subsided, a degree of economic uncertainty has been priced into the currency. Traders remain wary of the underlying fiscal challenges the UK faces.

The pound's value is a key barometer of international confidence in the UK economy. A weaker currency can exacerbate inflation by making imports more expensive. The events of the week serve as a reminder that the government's actions are under intense scrutiny, and any perceived misstep can have immediate and tangible consequences for the country's economic standing on the world stage.

The Challenge of Economic Growth

Underpinning the entire fiscal debate is the UK's persistent challenge with sluggish economic growth. Without a robustly growing economy, the chancellor's task of reducing debt while funding public services becomes exponentially harder. A growing economy generates higher tax revenues naturally, providing the government with more resources and making debt easier to manage as a proportion of national income. The current low-growth environment exacerbates every fiscal pressure point.

Critics argue that the government's focus on fiscal consolidation, while reassuring to markets, may come at the expense of pro-growth policies. The reversal on welfare policy, forced by political pressure, means that the government must now find savings or raise taxes elsewhere, moves which could themselves have a dampening effect on economic activity. This creates a difficult cycle where the solution to one problem can worsen another.

A Test of Leadership

The events of the week provided a significant test of leadership for both the prime minister and the chancellor. For Rachel Reeves, it was a moment of intense personal and professional pressure. Her ability to emerge with her credibility intact, largely thanks to the market's reaction, was a testament to the reputation she has cultivated for fiscal prudence. Her subsequent public statements demonstrated a resolve to stick to her economic principles despite the political storm.

For Sir Keir Starmer, it was a critical moment to assert his authority and stabilise a precarious situation. His swift and decisive public backing of his chancellor was instrumental in preventing a minor market wobble from escalating into a full-blown crisis of confidence. The episode underscored his understanding that in the modern economy, a prime minister must often speak directly to the financial markets to maintain stability.

The Road Ahead

Looking forward, the path for the UK government remains fraught with challenges. The £5 billion fiscal gap created by the welfare U-turn must be addressed in the upcoming Budget. This will require the chancellor to make tough decisions that will inevitably be unpopular with some segment of the population. The government will need to carefully navigate the political fallout of these decisions while retaining the confidence of the financial markets.

The lingering risk premium mentioned by Mohamed El-Erian suggests that investors will be watching closely, ready to react to any sign of further instability or deviation from the stated fiscal path. The government's ability to successfully manage the country's finances, maintain political unity, and foster economic growth will be the defining challenge of its term in office. The events of this week have shown just how high the stakes are.