Crying British Treasury Secretary hurts pound

For almost a year, the Labour government was well on its way to rebuilding trust in British politics. In recent days, however, a veritable soap opera has unfolded in the House of Commons. Chancellor of the Exchequer Rachel Reeves and the pound are the biggest victims.

On 4 July last year, the Labour Party convincingly won the British elections. This victory did not come as a surprise. The population was more than fed up with the chaotic policies and internal quarrels of the Conservative Party during Brexit and in the years that followed. After his victory, Prime Minister Keir Starmer therefore tried to make the contrast with the Conservative policy as big as possible. In negotiations with the European Union, the worst sore points of Brexit were massaged away. In addition, he did his best to nip internal unrest within the party in the bud and especially to regain the confidence of the financial markets with a decent budget policy. Within a week, he seems to have thrown all that beauty away.

Trapped by own party
Under pressure from the left wing, the Labour government is rolling back a number of austerity measures. For example, welfare benefits will not be reduced after all and a much larger group of pensioners will be eligible for the winter fuel premium than originally planned. This concession to its own supporters comes at a considerable price. This U-turn will mean the loss of almost £5 billion in savings. This puts Chancellor of the Exchequer Reeves in a very difficult position. She is obliged to draw up a policy that will not put her in the red in the 2030 budget year. With an expected surplus of £10 billion on a total budget of £1.500 billion in that year, she has little room for manoeuvre. There are already hints that she will implement unpopular tax increases.

Remarkable paradox in the British market
Meanwhile, it seems as if her chair is being increasingly undermined. When Starmer refused to give a convincing answer on camera last week to the question of whether Reeves would complete her term, most of the attention focused on the tearful Chancellor of the Exchequer in the parliamentary benches behind the Prime Minister. Two things happened on financial markets at that moment: the pound fell and the yield on British government bonds rose slightly. This is remarkable, as these factors don't usually go hand in hand. Under normal circumstances, higher capital market interest rates actually make it more attractive for foreign investors to hold their assets in the currency in question.

Painful choice
The rise in capital market interest rates indicates that investors are somewhat concerned about the ability of the British government to meet future obligations. On the other hand, the fall in the pound indicates that other UK assets are also less popular. After the shock, calm has returned to both the currency and the capital markets. The events of the past week bring back memories of a chaotic period under Prime Minister Liz Truss when the British public finances threatened to derail in 2022. Starmer and Reeves will therefore have to weigh their words carefully in the coming weeks. If they play away the confidence of financial markets, that will ultimately hurt a lot more than implementing a package of unpopular austerity measures.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

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