Reeves Faces Credibility Test After Reprieve From UK Markets

Chancellor of the Exchequer Rachel Reeves has emerged relatively unscathed from a series of high-stakes public tests this week in the UK. Her next challenge will be proving to investors that she can shore up her battered economic agenda.

Author of the article:

Bloomberg News

Julian Harris, Joe Mayes and Irina Anghel

Published Jan 15, 2025  •  4 minute read

4{2noopd9ftg82pwb3j}emp4_media_dl_1.png Office for Budget Responsibility

(Bloomberg) — Chancellor of the Exchequer Rachel Reeves has emerged relatively unscathed from a series of high-stakes public tests this week in the UK. Her next challenge will be proving to investors that she can shore up her battered economic agenda.

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The chancellor arrived back in Britain from China on Monday facing bond sales, a barrage of political criticism and some crucial data releases. The auctions have proved expensive, but revealed continued demand for UK debt. Meanwhile, an inflation reading on Wednesday came in lower than expected and eased a market rout that had pushed UK benchmark borrowing costs to a 17-year high. Gilts then got another helping hand from rallying Treasuries in the US.

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For her own part, Reeves was careful not to stoke the crisis when faced with questions in the House of Commons, blaming global headwinds. And Prime Minister Keir Starmer gave her his strongest backing yet on Wednesday, saying that Reeves would remain chancellor for “many, many years to come.”

The events provided some relief to Reeves. She had seen gilt yields rise sharply in the weeks around her October budget and again at the start of this year, threatening the credibility of her plans for faster growth and significantly higher spending.

Yet Reeves’ problems haven’t gone away. Yields were still high enough as of Wednesday afternoon to keep the finance minister at risk of breaking her own fiscal rules, according to Bloomberg Economics. She remains at the mercy of global bond markets between now and March 26 when the Office for Budget Responsibility, Britain’s fiscal watchdog, publishes an outlook that will determine whether the ruling Labour Party must impose even higher taxes or restrict spending.

The inflation data was “a useful figure for her when she looks a bit vulnerable,” said Steven Fielding, emeritus professor of political history at Nottingham University. “But the next set of figures could look pretty poor, and they’ll be at her again. Reeves and Starmer are going to be facing this pressure for some time to come.”

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GDP data on Thursday could also reveal the extent of Britain’s struggle to achieve consistently faster growth, while gilts and the pound remain vulnerable to events abroad. The return of Donald Trump to the White House, and prospect of a trade war and other inflationary policies, could blow the UK off track irrespective of the Labour government’s own decisions.

“They’re going to have to realize that they’re not going to be as ambitious on their spending plans as they’ve wanted to be,” Mark Dowding, chief investment officer at RBC Bluebay Asset Management, said on Bloomberg TV. Labour won’t be able to “transform public services until they can actually get the economy going,” he added.

Economists and market players have becoming increasingly skeptical that Labour’s fiscal plans are sustainable, with some arguing they are reliant on overly-optimistic growth forecasts by the OBR. It’s a tough problem to fix as Reeves has pledged not to return with another revenue-raising budget after lifting taxes by more than £40 billion ($49.2 billion) in October. She would prefer to rein in spending, people familiar with the matter told Bloomberg, but investors would need to be convinced that the left-leaning government could genuinely deliver any proposed cuts.

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The UK’s inflation print was a much-need boon for Reeves and her Treasury colleagues. Consumer prices rose 2.5% from a year earlier in December, down from 2.6% in November, the Office for National Statistics said.

Reeves didn’t mention the recent market selloff in her response to the inflation data but said there was “still work to be done” to contain inflation.

What Bloomberg Economics Says…

“We still think the BOE will be minded to cut interest rates gradually through the course of the year – both the economy and jobs market call for a less restrictive policy stance”

— Dan Hanson and Ana Andrade, economists. Click to read the REACT on the Terminal.

A cooling of service sector price growth from 5% to 4.4%, the lowest since March 2022, provided a “sigh of relief” for investors, according to Nomura economist George Buckley, even though it was largely driven by a plunge in volatile air fares and a sharp easing in hotel price inflation.

“We expect quarterly 25-basis-point cuts to a terminal rate of 3.5% early next year,” Buckley added. Traders ramped up their rate cut bets, fully pricing in two cuts this year, having started the day with a less than 50% chance of a second cut.

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Nonetheless, economists have warned that inflation could climb back above 3% in the coming months, partly due to higher energy and fuel costs. There remains a sense that Reeves is presiding over an economy at risk of “stagflation,” a dreaded combination of high prices and anemic growth that goes a long way to explaining why investors have gilts and the pound in their cross-hairs.

“What is key for our economy is to get growth going, but this has been killed stone dead by this government,” shadow chancellor Mel Stride said in a statement, referring to Labour’s £26 billion increase in payroll levies. “The chancellor needs to urgently explain how she will now achieve this.”

—With assistance from Andrew Atkinson.

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