HAMISH MCRAE: Bumpy summer ahead for Britain's finances

Daily Mail​

24-05-2025

The bond vigilantes are on the warpath, and this is bad news for the Chancellor. They are prowling the streets everywhere, hunting down any government they think is borrowing too much and beating it up by pushing up long-term interest rates.
The UK is not alone. The US and Japan also saw the cost of financing their national debt rise last week. In the case of America, it was mostly a reaction to Donald Trump's 'big, beautiful bill' passed by the House of Representatives, which cut taxes and increased spending. It looks like it will boost their fiscal deficit to 7 per cent of gross domestic product (GDP), scary indeed.
For Japan it was a more general concern that since the national debt is more than double its GDP, the declining population will not be able to pay the interest on it, let alone get the number down.
But while other countries have dodgy national finances, we are very much in the firing line – and for good reason. Last week there were two chunks of bad news.
One was inflation, with the Consumer Prices Index (CPI) climbing to 3.5 per cent. This was billed as 'unexpected', although anyone who didn't expect it has been reading the wrong newspaper.
It certainly makes a mockery of the recent cuts in interest rates by the Bank of England, given that the bank has a mandate to bring inflation down to 2 per cent.
The City expects at least one further rate cut this year, but I think it is perfectly possible the next move will be up, not down.
The other was the news that in April, the first month of the new financial year, the Government's deficit went up. Revenues were £5.6 billion higher than in April 2024, but spending was up by £6.6 billion. The increases in public sector pay more than wiped out the rise in employers' National Insurance Contributions and the Chancellor's other tax increases.
Looking ahead, it gets worse. A quarter of our national debt is index-linked, and to the Retail Price Index, which was 4.5 per cent last month, even higher than the CPI. Inflation is also likely to push up the state pension next year. This has just gone up 4.1 per cent, thanks to the so-called triple lock, where pensions rise by the highest of three things: the CPI, average earning increases in the previous autumn, or 2.5 per cent.
This year it's been rises in earnings that were the top marker. We don't know what they will be in four months, but they are now 5.6 per cent and inflationary pressures may push them higher still.
So the Government may have to confront the harsh fact that, if it honours its commitment to keep the triple lock, that will blow an even bigger hole in the finances.
The bond market knows all this – that is why it pushed the yield on ten-year gilts above 4.75 per cent in trading on Friday. The US is paying about 4.5 per cent.
Is it unfair that we should have to pay more since objectively our national finances are no worse than theirs, arguably a bit better?
Sure, but markets are not fair and our Government must live with the fact that it is distrusted by those who can lend it money.
The practical question for the rest of us is how to protect ourselves if there is a coming crunch.
In the continuing chaos we have to accept two things.
One is that short-term interest rates may not fall further and may start climbing again. The other is that Government bond yields will probably rise, with ten-year gilts settling above 5 per cent. If that is right, anyone needing to borrow should bolt down the best deal as soon as possible. Pessimistic, yes, but better safe than sorry.
As for investment, higher bond yields are usually been associated with lower equity prices, but equities give protection against inflation and the UK market is cheap by historical standards.
So the common sense rules still apply: in the long view shares are better than bonds and you should always spread risk. We shouldn't be frightened by what is happening. But we should be aware that if markets are bumpy now, they are likely to be a lot more so through the summer and beyond.