Labour's chaos exposes Britain to a new economic shock

Telegraph

04-07-2025

That is precisely what is happening at the moment. A series of about-turns on key policies have sent Reeves's financial plans into tailspin and shaken faith in Labour's competency.
'The changes we have seen ever since the first announcements from the Labour Party – and the intended changes they wanted to put forward – have subsequently been either watered down or changed. That's what the bond market does not like,' says Sonja Laud at L&G investment management.
'[Markets] can't trust that what's been put forward will be put in place.'
Simon French, the chief economist at Panmure Liberum, says constant flip-flopping on policy is starting to 'look like ineptitude'.
He adds: 'The issue for the Prime Minister is that this ineptitude is rather deeper than scapegoating one person – even his Chancellor. This looks like a systemic problem within his own party.'
Some in the City are already speculating about life after Reeves.
'Perhaps the markets were even thinking forward to the possibility of Angela Rayner as PM,' says one financier. 'They would view the current deputy PM as absolutely increasing the fiscal risks.'
For now, the market reaction has been relatively muted. But El-Erian warns that bad news can quickly compound to trigger pyrotechnics in the bond market.
'That happened during the Liz Truss period when bond markets were already destabilised by what was happening in the US and then you got a UK-specific shock that amplified to a tremendous amount the move in yields,' he says.
'If you ask me what's the greatest vulnerability, it's when both of these things happen at the same time.'
As the Office for Budget Responsibility (OBR) has highlighted, it wouldn't take much to knock Reeves off course. Had the rise in gilt yields on Wednesday been sustained, it would have reduced the Chancellor's £9.9bn buffer by £3bn. That's before taking into account the cost of all of the welfare and winter fuel payments climbdowns.
As it stands, much of the surge in gilt yields went into reverse after Sir Keir Starmer finally offered a full-throated endorsement of his Chancellor, saccharin as the love-in was.
Yet borrowing costs are not back to where they were before Sir Keir gutted his benefit reforms to head off a rebellion.
'Wednesday's moves serve as a reminder of how parlous the UK fiscal situation is, and that it is testing investors' patience,' says Diana Iovanel, at Capital Economics.
'There is very little fiscal headroom, and all of the options available to Reeves are unappealing.'
Shock waves from Trump's big beautiful bill are just one risk facing Britain. As the war in Ukraine has demonstrated, the UK is also vulnerable to global energy prices, and the recent US attack on Iran was a reminder that geopolitical tensions can quickly escalate.
One of the clearest ways such events affect the British economy is through inflation. In an unstable world, things tend to cost more.
The danger is that an inflation shock forces the Bank of England to keep interest rates higher for longer, further eroding Reeves's headroom and forcing her to find savings or raise taxes even further.