Key events
The pound is pushing higher too!
Sterling has now gained a third of a cent against the US dollar, up to $1.366.
That means it has recovered roughly a third of yesterday’s tumble.
UK bonds rally as panic eases
The bond market is looking calmer this morning, as traders welcome Keir Starmer’s endorsement of Rachel Reeves.
The prices on UK government debt are rising in early trading, which pulls down the yield (or interest rate) on the bonds.
The yield on UK 30-year bonds has dipped by 0.8% in early trading, to 5.361%. Yesterday it had surged by over 3% to 5.408%, from 5.234%.
UK 10-year bond yields have also dipped by around three basis points, to 4.55% from 4.58% last night.
These moves suggests the bond markets are relieved that Starmer is standing by Reeves, easing concerns that a new chancellor might be less committed to the fiscal rules, so might look to borrow more.
But while today’s recovery eases some of the pressure on the government, it doesn’t wipe out all of Wednesday’s jump in borrowing costs – traders will be wondering how the government will patch up the multi-billion pound black hole in the public finances.
Shorter-dated two-year and five-year bond yields have also slipped back, as prices recover some ground.
El-Erian: bond sell-off would add £1.8bn to government spending, if it sticks
The jump in UK borrowing costs yesterday will have added to Rachel Reeves’s fiscal problems, unless it reverses.
Mohamed El-Erian, chief economic advisor to insurance giant Allianz, has calculated that Wednesday’s rise in bond yields would add £1.8bn to government spending each year, “if it sticks”.
He told Radio 4’s Today programme that it’s “very hard” to take a risk premium out of markets, explaining:
The minute you put a risk premium in the marketplace, it’s very hard to take out. I suspect that we will see some moderation, but we will not go back to where we were 24 hours ago.
El-Erian says investors have been reminded that the UK’s fiscal problem is “deep”; without growth, we face a “vicious cycle where every action you try to take is either economically problematic or politically problematic,” he adds.
He then warns that Reeves’s fiscal headroom of about £10bn (the margin before she breaks her fiscal rules) is “essentially gone”.
That means she must find at least £10bn of measures in autumn’s budget, and that bill will go up if growth slows or borrowing costs rise further.
And that money may have to come from taxes.
El-Erian explains:
So the area left are the two taxes that the Labour government ruled out in the election, income tax and VAT. They are your major sources of tax revenue.
No one likes them, but in a world like this, they will become better than the alternatives.
Pound calm as Starmer backs Reeves
After a tough day yesterday, the pound is calmer in early trading.
Sterling is marginally higher (+0.08%) against the US dollar today, at $1.3646, having dropped by a cent yesterday.
The calm follows backing for Rachel Reeves from Keir Starmer.
He told the BBC that the Chancellor has done a “fantastic job”, adding:
“She and I work together, we think together. In the past, there have been examples – I won’t give any specific – of chancellors and prime ministers who weren’t in lockstep. We’re in lockstep.”
That may reassure investsors worried that Reeves could be replaced, and that a new chancellor would be less enthusiastic about controlling borrowing.
Simon French, chief economist at investment bank Panmure Liberum, argues that “almost all other Chancellor options from within the parliamentary Labour Party” are less market friendly options.
French told clients:
Recent weeks have shown that large parts of the parliamentary Labour Party in the UK do not have the stomach for the tough fiscal choices required in a normalised interest rate environment, amidst sluggish productivity growth, with the tax burden at an eight-decade high, and with a deteriorating demographic profile.
The lack of a working majority for its economic plans leaves the Labour government with an intractable problem – its credibility with financial markets hinges on adherence to a set of fiscal rules that are incompatible with its manifesto tax commitments, and the plans outlined at the recent Spending Review.
Introduction: Bonds and sterling in spotlight after Wednesday wobble
Good morning, and welcome to our rolling coverage of business, the financial markets and the world economy.
All eyes are on UK bonds, and the pound, after both fell sharply yesterday amid speculation over the future of chancellor Rachel Reeves.
Wednesday was a turbulent day for the UK bond market; prices of British government debt fell heavily as investors were gripped by concerns of change at the top of the Treasury. The selloff highlights anxiety that the government’s u-turn on welfare reform has blown a multi-billion pound black hole in the chancellor’s budget plans.
Bonds slumped, driving up borrowing costs, after Keir Starmer failed initially to give his full backing to Reeves at prime minister’s questions, with a tearful chancellor alongside him.
The pound also suffered, falling by a cent against the US dollar as it slid from $1.3745 to $1.3636, making it the worst-performing major currency in the world.
Starmer has now defended Reeves, saying her tears were due to a “personal matter” and insisted she will remain chancellor “for a very long time to come”.
The bond selloff may actually have reinforced Reeves’s position as chancellor, highlighting that the markets would not welcome a replacement who might be less devoted to fiscal discipline.
Andrew Wishart, economist at Berenberg Bank argues that “Investors probably saved the Chancellor”, saying:
By selling sterling assets investors have probably kept UK chancellor Rachel Reeves in her post. Financial markets initially reacted little to the government failing to get approval for savings in the disability benefit budget from its own parliamentary faction. But when the Prime Minister failed to say that a visibly upset Reeves would remain in her job during Prime Ministers Questions, UK assets sold off.
The Chancellor has become synonymous with a fiscal rule of covering day-to-day spending with tax revenue.
That fiscal rule may dictate tax rises in the autumn budget, as spending cuts could be too much of a political headache, judging by the massive rebellion against the welfare bill that has created a £5bn hole in the chancellor’s plans.
America’s economy may take the market spotlight off Reeves this afternoon, when the latest US jobs report is released. It will show whether trade war tensions have hit hiring at US businesses.
The agenda
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9.30am BST: UK service sector PMI for June
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10am BST: OECD Economic Survey of the European Union and Euro Area
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1.30pm BST: US non farm payrolls employment report for June