ALEX BRUMMER: Budget risk of rising rates

The fretwork of any budget is the state of the public finances. The closer we have moved towards Rishi Sunak’s March 3 statement, the greater the number of revenue-raising kites which have been flown. 

The Chancellor is in a bind as the pandemic budget deficit and the volume of national debt have soared. 

Treasury orthodoxy dictates that the Government needs a flightpath, over five years, to restore some kind of balance to current spending. Capital spend on infrastructure, or investing with the private sector and universities in new technologies such as fuel cells for electric cars, or hydrogen to power locomotives and lorries, has a longer and less urgent trajectory. 

Amid the myriad voices heard in the budget build-up, the case for caution in the public finances has been well made by ex-chancellor ‘Spreadsheet’ Philip Hammond. He has a point. Covid economics, as preached by the International Monetary Fund (IMF), is spend and avoid slump. 

Decision time: The Chancellor is in a bind as the pandemic budget deficit and the volume of national debt have soared

In the US, which never usually listens to the IMF, President Biden has taken up the challenge. His $1.9 trillion fiscal package, with perhaps a further $1trillion to come, on updating the US’s ageing infrastructure is on the scale of Franklin D Roosevelt’s New Deal. It is radical enough to have divided the big voices in Democrat economics. Treasury Secretary Janet Yellen is in favour and one of her predecessors Larry Summers is in the Hammond camp. 

Financial markets have been making up their own mind. The combination of big spending and monetary laxity is stoking future inflation fears, causing bond prices to tumble around the world and sending interest rate yields higher. In Britain the most upbeat of Bank of England policy makers, Andy Haldane, argues in an online speech that the tiger of inflation has been stirred by the extraordinary events and policy responses of the past 12 months. 

The record of the Bank of England in containing the tiger over the past quarter of a century has been good. 

Better in fact than at any time in the last 800 years, as deputy-governor Ben Broadbent told the Commons this week. 

Taming inflation comes at a price. In the US, the prospect has caused what Barclays calls a ‘yields tantrum’ with the cost of ten-year money jumping to 1.5 per cent. 

In the UK the interest rate on one-year bonds has moved back into positive territory and the ten-year gilt yield has climbed 61.27 per cent to 0.787 per cent over the past year. That is fantastically low by historic standards, but the trend is very pronounced. 

What it tells the Chancellor and Treasury mandarins is that the age of government borrowing for next to nothing could be drawing to a close. 

It is not a huge problem at present and the 2020-21 budget deficit, now expected to come in below £400billion, has been financed. 

However, if inflation should perk up towards or even beyond the Bank’s target of 2 per cent, there could be trouble ahead. 

A jump in bank rate and higher bond yields will raise the cost of servicing the existing debt pile of £2 trillion-plus, and with even more to come it could become onerous. Tax revenues have been buoyant in the pandemic, in spite of business rate and VAT breaks, and it is just possible that the UK could melt the current deficit away by growing. 

That may be a laudable free market approach. But the risks of doing nothing, and the wheels coming off, are too high.

Plane speaking

In some ways IAG, owner of BA, Iberia and much else, is pursuing a similar approach to HMG. 

Britain’s flagship carrier has refinanced itself through cheap borrowing, is holding its nerve through the pandemic and trusting previous dominance of the skies – especially across the Atlantic – will come back. 

How fascinating to think that in 2019 the squabble with the unions was all about the share out of £2billion or so of profit. The same Bolshie workforce is quieter now that losses-before-tax have soared to £6.7billion (after heavy exceptional charges). The short-term request from IAG is some form of digital vaccine passports. But the bigger, long-term worry must be that the magic of Zoom, Teams et al will mean that the business travel market is uprooted forever. 

It is going to be a nervy, testing time for investors, passengers and staff.