Merlin Weekly Macro: Reeves in tears, UK fiscal plan in tatters

One Unhappy Birthday

Not only the worst first anniversary he could have imagined for Keir Starmer’s administration, for the Chancellor also a week of nightmares in a never-ending series of confidence-sapping calamities.

Monday: the Bank of International Settlements (BIS) joins the International Monetary Fund (IMF) in saying the UK’s fiscal trajectory is unsustainable and the enduring deficits and mounting debt pose a systemic financial risk. Tuesday: the day begins with AstraZeneca, the UK’s largest quoted company, saying it is considering transferring its listing to New York; then followed the political car-crash of the collapse of the government’s flagship Benefits Reform bill and the wheels falling off the Chancellor’s fiscal assumptions. Wednesday: a profit warning from the nation’s favourite baker, Greggs, citing alongside the heatwave diminishing appetites for large sarnies, a rapid increase in costs arising from Reeves’s big hike in employers’ National Insurance and the minimum wage; then we had tears before lunchtime at PMQs and the markets assuming her days in post are numbered. Thursday: a series of rapidly contrived photo opportunities featuring overworked praise for the Chancellor, much enforced laughter and Reeves and Starmer hugging in front of the cameras; it only reinforced the perception.

“Give me lucky generals.” That was Napoleon’s maxim. Alas, today in the UK, Prime Minister Sir Keir Starmer finds that neither he nor his subordinate generals are in any way lucky; not even unlucky or hapless, they are verging on incompetent. Starmer’s position is compounded by a significant cohort of MPs who, however well-meaning, idealistic and morally righteous, are largely economically illiterate.

Labour inherited a weak economic and financial position from the Tories; that is undeniable. However, as we dissected last autumn in the run-up to the Budget, the sudden appearance of a previously unidentified ‘£22bn black hole’ in the government’s finances was not only a politically contrived fabrication, but it also revealed a worrying level of unpreparedness and an amateurism for the serious business of fiscal planning in office. The day after Rachel Reeves’s Budget eight months ago when Opposition Leader Rishi Sunak had verbally lacerated and surgically dismembered her statement, we wrote in these columns, “She was looking hunted. She knew she’d been rumbled… Starmer could not look and instead his eyes found something in the upper gallery that was suddenly very interesting …However big its majority, this was a government unexpectedly under self-inflicted pressure on its showpiece battleground.” In terms of fiscal policy, that was the high point, the last time the government was in control of the agenda; it has been downhill all the way since for which it has nobody to blame but itself.

In office but not in power

Twelve months on from winning its stunning election victory with a landslide majority of 174 seats and what should have been leaving the opposition trailing as almost irrelevant in its wake, Starmer’s administration has seen its authority evaporate. It seems incredible that almost a year to the day since taking office, Starmer had to face down what was rapidly in danger of becoming a vote of no confidence in the government from its own side as he and his back benchers found themselves at war with each other. It was not so much that he blinked in the game of political poker: he simply buckled and surrendered to a mass revolt.

The conflict was the Benefits Reform Bill. Hardly an unexpected flashpoint, this was a slow-burning fuse that was ignited with the peremptory withdrawal of the Winter Fuel Allowance last October; it was allowed to accelerate when further health and disability benefits reforms were socialised in the Spring to save £5bn; it rapidly went from flash to bang as the back bench groundswell of opposition became explosive. Preaching sedition, Labour mayors Sadiq Khan (London) and Andy Burnham (Manchester), both senior Party members, appealed to Labour MPs to vote against the government. With open rebellion in the ranks and the worst public approval ratings for a prime minister in a generation for Starmer (and he’s up against some stiff competition), how appropriate that his has been dubbed ‘The Loveless Landslide.’

Politics is a rough-tough game. It is no place for shy and retiring flowers: prerequisites are the constitution of an ox and the hide of a rhino. There are many thoroughly decent people among MPs, imbued with a genuine sense of public service, but it is an exceptional member who is above practising the dark arts necessary for political survival or advancement. The temptation to throw rocks at the opposition and to pull the rug from under your own colleagues becomes almost irresistible. For which you must expect the same in return. The cut and thrust of ‘doing politics’ in the pursuit of policy and power runs in the blood.

Which makes Keir Starmer a Westminster oddity. Identified accurately by Charles, Lord Moore, a former editor of the Daily Telegraph and official biographer of Margaret Thatcher, Starmer suffers two potentially terminal handicaps: a) he does not enjoy politics and b) he is not very good at it. It is a major disadvantage when politics is your chosen shark-infested pond in which to swim, and even more so if you happen also to be the Prime Minister.

Being a 21^st Century head of a major democratic government is impossibly demanding. Crises need immediate but deft handling; one wrong step can be politically fatal. In a 24-hour-a-day, 365-day-a-year job under relentless and constant real-time scrutiny in the modern multi-media world, the exigencies of being the government’s executive chairman at home and its almost perpetually globe-trotting ambassador abroad require near-superhuman qualities: organisation; focus; multi-tasking; mastering complex briefs; physical stamina. The days when patrician leaders such as Asquith, Douglas-Home and MacMillan could set aside a couple of hours each weekday afternoon for a snooze or a walk, or take the weekend off for culture, rest & relaxation, perhaps a spot of fishing or shooting, or Time For Thinking Great Thoughts, are long gone. We have discussed previously Starmer’s FOMO, fear of missing out on the international stage. The airport travelator and competing for international influence and attention combined with the domestic pressures of the job in No 10 and his natural personal disinclination to put in the hours pressing the political flesh in the Westminster tea rooms, bars and the voting lobbies, have left him aloof and isolated from his parliamentary party. Many were only elected for the first time a year ago and barely know him anyway. That rapport, the type which engenders loyalty and support, especially in testing times, is absent. In essence, he lacks leadership. The results are self-evident.

The broken glass that was ‘Securonomics’

Rachel Reeves has been equally inept. Her self-proclaimed brand of ‘Securonomics’ designed to ‘restore financial order after the Tory chaos’ was a bold attempt to build a reputation as the new Iron Chancellor. But it was obvious even before the election that Securonmics were on shaky ground: embarrassingly, she had to slash the massive net-zero budget that was intended to mark her out as the ‘Greenest Chancellor ever’ (it was reported that despite having worked at the Bank of England, she had not fully understood the implications of rising Gilt yields on nominal borrowing costs and had significantly underestimated the likely interest bill on the government’s debt; it was an inauspicious beginning for a prospective Chancellor endorsed by Mark Carney, a previous governor of the Bank of England).

Stamping her personal label on the economic programme at the Budget, the March Statement and the recent Spending Review, she has constantly hammered home the proposed programmes for operational expenditure and capital investment, and the definition of her own fiscal rules, as ‘my choices’, ‘my decisions’. Now that her fiscal headroom has all but evaporated again as she finds not for the first time that her sums do not add up, she has left herself politically vulnerable.

Tory leader Kemi Badenoch’s cheap shot at Reeves’s personal distress was unedifying, but in their own brutal way markets were also unforgiving: at the excruciatingly painful Prime Minister’s Questions in the aftermath of the Benefits Bill fiasco during which Reeves was in tears, markets smelled instability. If she was to be jettisoned (or indeed were to resign), would her self-imposed fiscal rules survive? Will they even if she stays? Immediate response: jack up the risk premium. Up romps the UK 10-year Gilt yield on the dot of the first tear from 4.50% to 4.67%, while the 30-year Gilt rose as sharply from 5.27% to 5.45%; down went the pound. Markets remain unconvinced by Starmer’s public backing offered too late in the day when the damage was already done.

However much Starmer now dons the sack cloth and ashes and issues mea culpas to all and sundry for not listening and misjudging the situation about social policy, his political platitudes miss the fundamental point: having capitulated with the immediate result of an unplanned £5bn hole in Reeves’s operating budget, his serial political backtracking has reduced the government’s fiscal plan to tatters.

Gross acts of self-harm

What is so distressing, which leads to the charge of incompetence, is that today’s parlous financial situation which has caught the critical eye of both the IMF and BIS, is the result of a series of unforced errors in the last year.

It was craven party politics to give unconditional inflation-busting wage rises to the public sector unions to buy them off: offered the same again a year later, doctors and nurses have dismissed the new round of pay offers as derisory. Starmer scored a big own goal when the Mauritians announced that Britain’s £9bn payment to lease the island of Diego Garcia which it already owned, would be used to allow 80% of the Mauritian population to pay no income tax, at the same time as UK ministers were deep in negotiations about saving £5bn on domestic welfare and disability payments. Starmer had known since January that the defence spending bill was going to rise to as much as 5% of GDP, double what he was holding out as the UK’s public limit; therefore it was reckless to proceed with a huge capital spending spree announced at the June Spending Review that included a knowingly half-baked defence spending assumption. There have been plenty more.

The socialist trope: Tax & Spend

So where from here? Power now resides with the Labour back benches as to what they will allow by way of reforms or spending cuts. The intent is clear: very little if anything of real substance that is radically different. The cabinet is no longer in control of policy.

So, if it is not about savings, to balance the books requires more income. The Far Left is clamouring for tax rises despite the tax burden being the highest in eight decades (what they really mean is that the top 1% of earners who already pay 28% of all Income Tax, and the top 10% who account for 60%, should be tapped even more for the greater good: it might not be as crude as changing the tax rate but back on the table are wealth taxes on capital and property, the potential to harmonise the CGT rate with Income Tax, more messing about with pensions allowances and taxing ‘unearned income’ as well as the usual fiscal drag through freezing Income Tax bands).

Risk a punch-up with the bond markets by relaxing the fiscal rules and we know what happens: the Bond Vigilantes immediately mark up the cost of borrowing defeating the object of the exercise.

Grow the economy? If only! However much Labour bleats on about the need for growth, the warp and weft of virtually every Labour policy combines to create a strait jacket that constrains the potential: higher employment taxes; uncompetitive energy costs; punitive ‘windfall’ taxes on energy companies and banks; frictional business costs from employment policy; the wilful destruction of the continuity of capital in small businesses through new IHT liabilities; the irresistible urge for government intervention and regulation. The list goes on.

Confronting hard truths

The hard truth is that the UK economy is suffering a lingering and debilitating malaise: with a surplus of unproductive adults but a shortage of productive labour, and capital inefficiency tied to uncompetitive production costs, it is operating far below its optimum capacity. As it becomes embedded, it has defied and defined every UK government for quarter of a century.

Discussing the US but absolutely applicable to the UK, a correspondent, PJ Allen of Illinois, writing a letter in the FT this week summed it up perfectly: ‘Even in today’s hyper-partisan politics, the one thing most Americans agree on is that they want the government to do more than they (the electorate) is willing to pay for.

Republicans want tax cuts, but they don’t want the government to do less, except for “de minimis” things like foreign aid. Democrats, on the other hand, want to increase all kinds of social programmes, but they somehow think this can be paid for by increasing taxes on “the rich”, i.e. other people’. Substitute Britons for Americans, Tories for Republicans and Labour for Democrats and that is a perfect reflection of 25 years of British political economic and social attitudes.

Which brings us back to leadership. Compare and contrast this week: working with wafer thin margins, Trump’s One Big Beautiful Bill (his highly controversial flagship fiscal budget) emerged from ‘intense negotiations’ in Congress almost entirely intact, without any coincidence perfectly timed to land for Independence Day; with what should have been an unassailable majority behind him, Starmer’s Benefits Reform Bill was almost entirely eviscerated. Starmer allowed himself to be trampled upon; in Trumpland, Trump does the trampling. You make your own luck in this game.

It is 50 years ago next year that Labour Chancellor Denis Healey had to go cap in hand to the IMF for a bail-out. Today, the IMF’s fiscal ambulance is ready, fuelled, the defibrillator is charged and the oxygen tanks are full; it is waiting for the ‘shout’. It will be a low moment if we hear the two-tones and see the blue lights heading towards us. The need for the emergency services is entirely avoidable. But perhaps we have to suffer the same experience as Greece and Argentina before we realise it and get a grip. Whatever, as the BIS and the IMF have made plain, this is no way to go on. Let’s hope Starmer’s remaining years are markedly better than his first.

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