Structural challenges and the future of governance

Pushkin The UK political Merry go round has rotated once again and we have a new Prime Minister in Waiting Today on the show UK politics and UK markets and the connections between them This is unhedged The Markets and Finance podcast from the Financial Times and Pushkin. I am Rob Armstrong, coming to you from my home in Brooklyn, New York. Joining me today is the incomparable and irreplaceable Ian Smith all the way from London Ian. What is it you do for us again? What's your job? I'm a senior markets correspondent Rob here in London. I am going to be the surrogate American listener today. and pretend to be even more ignorant than I am about what's going on over there in markets and in politics. So let me start with a Broad question You have a new prrime minister in Wayden He is some kind of pinko communist, if you believe what you read in the American press And yet the Gilts market, which is supposed to be the thing that keeps the pinko communists over there in line is going up or at worst, is indifferent to the whole thing What is going on? Maybe you can start by just giving us a thumbnail sketch of who this person is. So Andy Burnham is the mayor of Greater Manchester. He's just won the Makerfield by election, which has given him a seat at Westminster and means he is likely to become our next prime mininister in a string of prime mininisters in recent years. It's a brave new era in British politics It's a lock though, right? It's going to be him. There's not there's no chance somebody sweeps in at the last minute here. It's going to be him It's going to be him. It's a lock he's a really interesting figure, a senior labor figure for some years. know, figurehead on the left of the party, a champion of devolution, moving more power away from London and to other areas of the UK. He gave a big speech this week on moving some of the power in the UK away from Westminster. So it's a really interesting time that he's taking over, but he obviously inherits a lot of the challenges that Sir Kir Stahmer, who will be leaving as UK Prime Minister faced, such as the UK's high debts, its sluggish growth, its unstable politics. So it's not going to be easy for him No The Guilts market at least looked at naively, glancing at the chart of the ten year. Gilt yield doesn't seem to be that worried on his behalf that it doesn't seem to be signaling that he's a fiscally irresponsible person Or you know, he'll reignite inflation and so on. What do you make of what Gilts are doing right now? So it's interesting. Yeah, as you say, he's much caricatured by investors, Andy Burnham. I spoke to investors when he was you know, coming to the fore and there was a lot of leadership speculation around Starmer. He was viewed among the leading candidates as the most market negative of them There's a perception among youril investors that he will look to borrow more and he will shift the party and the government to the left And yet when it became very clear that he was going to become the next UK prrime mininister, the market reaction has been very calm Sterling has been very stable. Guilt yields actually took down, which means prices rose on the day that he won the Makerfield by election. So the reaction has been very calm from investors. I think there's a few reasons, some of which have nothing to do with the UK, which is the inflation threats to the global economy and to the UK are listening with the Iran warar to some degree abating, but some of them are about the things that he has said in the face that he has presented to investors and he sought to present himself as more of a centrist figure Let's start with the war It was striking to me That In the war inflation scare, which was a global event where it looked like we weren't oil prices were going to go bananas there was going to be second order effects on prices all over the world. We actually started to see that in some places Yields everywhere went up. Government bond yields everywhere went up, meaning government bonds Prices were down But it was the UK that turned out to be the most sensitive In other words, yields on the ten year guilt. moved up faster than those of other big developed countries, especially those in Europe How do we explain that sensitivity. That's partly because the UK came into this conflict with inflation running higher than elsewhere. It was about three percent in the UK. so it was higher than it was in the euro area. So that burst in inflation from the war fueled inflation that was already starting at a higher base. it also meant that there was a particularly sharp movement in interest rate expectations in the UK where people coming into the conflict thought there might be a couple of quarter pointint cuts the Bank of England interest rate. and in quite short order, they moved to expecting increases to the interest rate. So there was quite a sharp shift in that because of the rising inflation expectations. That's partly because we have a lot of gas boilers. I have one and other reasons why we were sensitive to an energy shock coming from the Middle East. know, our particular inflation sensitivities, which are one reason why we have the highest borrowing costs in the G seven already. we started from this higher base on inflation and interest rates and this war really made that worse. So yes, UK, France, Italy, you saw the bonds trade together in the early weeks of the conflict, but the UK was particularly hard hit. And there were also some hedge fund trades in the UK, people that had been expecting B ofV rate cuts that you saw got kind of turned around and that seemed to exacerbate some of the moves at the start of the conflict feeles like the UK is just somehow evenven putting aside the energy question, the UK is just more exposed to the winds of the global economy than many countries In other words, the world gets kind of two percent inflation. The UK always seems to get three. or There's a global economic slowdown or acceleration and the UK seems to accelerate or slow down more Is that because it's kind of a trading? I mean, maybe I'm exaggerating this, but is that it's a trading nation, It has connections to Europe etcetera, et cetera. Do you I point to is real? Yes, it's real. And also, you know we tore up our relationship with our biggest trading partner, right? So we have had sticky inflation since Brexit which has made all of these things worse. We've also had elevated borrowing, so that's fed into some of our high borrowing costs that we have, which has created like a bit of a negative feedback loop in our politics where you know, there's not a lot of room for manoeuver for centrist politicians. They try and they try and keep the bond market quiescent and you know, not rock the boat, but that also means they're constrained in what they can do and their spending priorities. That's fed some of their unpopularity. and you've seen the rise of the populist parties on each side of UK politics. That's something that happens in a lot of different countries that we see at the moment. But the UK, obviously we do have that mix of unstable politics, sticky inflation, fairly high Gilts issuance. And what we don't have, like the US has, is the world's reserve assets. So people don't have to buy Gilts in the way that they had they used to And we areactly. currency that can be targeted by international investors when there are worries about UK fiscals. So you can see us getting beaten up, but part of it is just comes back to inflation. But what's been interesting is as the conflict has gone on and now with a peace deal and hopes that the inflation shock won't be as bad as expected, you've seen some of the interest rate expectations fall back You've also seen some softer economic data in the UK, including inflation running lower than expected And that sparked a bit of a rallying guilt in the run up to this election of Verham at the Makerfill by election. So actually the backdrop is not so bad for him now. It was would have been terrible at the start of this conflict, But now we've had a couple of months of Yuiltk prices rising and yields tightening, and that has made some of these fiscal questions seem a little bit less drastic than they might have done Yeah, he has a little bit of space I want to turn the discussion to the future now rather than starting with Burnham Let's start with the Bank of England And what they're going to do about rate policy because Burnham, of course is going to have to respond to that So where is the BOE now and where are they headed? So I think this is the big question and it is actually a bigger question for the Gilt market than who does Andy Berham pick to be his chancellor? I think it depends on your time frame there. But the real proximate question for Gilts is what does the Bank of England do? Will it get away with not having to increase interest rates at all during this like rise inflation that we've seen linked to the Iran warar Now traders are expecting now maybe one quarter point rise to the BOE rate from the current three point seven five percent. by February and they had been expecting a couple of quarter point rises by the end of the year. So you can see that it might be that the Bank of England doesn't have to follow the European central bank and actually increase interest rates So some of the economic data oning over the coming months is going to be really interesting to see whether because the UK economy actually isn't in the best spot right now might not have to increase interest rates, might have to keep them lower to support the economy And that might help keep guilt yields anchored versus other major bond markets and provide a bit of a better backdrop to some of the political risks that we'll see. There's the bank of England. What about Burnham himself What do you expect from him in the weeks to come? I thought it was interesting you commented He's been quite good Calming markets with the stuff that he's saying Do you expect that to continue? Are there big speeches coming up? We should have an ear out for What are the kind of next steps with his premiership? So some of the things that Berham has said in the past, he's talked last year about not wanting to be in hoc to bond markets, comments which triggered much criticism from investors obviously and some hilarity in other quarters. He's also talked in recent months about taking some of an uplift in defense spending outside of the UK's fiscal rules. So these are the self imposed borrowing limits that we have. trying to debt as a share of GDP falling by the end of the Parliament So from saying those things, which are really the reason that investors were seizing upon them and saying T is more of a market negative a candidate that would shift labor to the left and lead to more borrowing He has now said I stick very much to the fiscal rules as they are currently written. His team have walked back those comments he made around defense spending. and he gave a big speech this week where he was very to emphasize his fiscal discipline and also talked about bearing down on areas like welfare spending. So a lot of investors responded to that speech quite positively, saying that he's showing some acceptance of the constraints on the UK So the big questions are Who does he pick as Chancellor? Are they going to be someone that is more continuity Rachel Reeves, who's been in recent months at least very much kind of a friend of bond investors in terms of trying to to the fiscal consolidation that she has been pursuing. alsoso, what will Andy Burnham actually do? He has now said a couple of different things about what he'd like to do with UK borrowing. He also has big spending plans. So there really is a suspicion among investors that he will seek to loosen the purse strings to some degree, and maybe he'll be emboldened by this stable reaction in the market that we've talked about to his premership becoming very real. You know, one investor put it to me said that they be a kind of game of chicken now between Burnham and the bond market where he might want to test just how far there is some acceptance of him pushing the needle on spending Yeah, this was what was alarming about that I don't want to be in hk to the bond market One of the terrible facts, not just about the UK, but about life in general is that we are all in hk at all times to the bond market. It is just it's not up to us as we all find out at one time or another. too a certain extent, whatever tune the bond market plays, that's the tune we have to dance to But I like at the same time, your analogy of a game of chicken The market is giving Burnham a bit of rope Will he take it And I suppose if you interpret him as saying, I don't want the bond market to be the kind of driving force in political decisions, political leaders have to lead, we have seen some of the problems that fiscal rules have created in terms of our economic policy, where you've seen the current government try and rebuild the buffer that they have against their borrowing limits by doing things that actually feed inflation or are unpopular know so you have this kind of doing economic policy to kind of keep within these rigid tram lines in a way that maybe makes the government more unpopular and less stable. So him saying I want to kind of the initiative and lead and this is how I want to do it. invvestors said you know can respond well to that. If he does actually foster growth, growth is a great way to get yourself out of a debt squeeze. So if he can convince people that he can lift UK out of this growth funk, then he will be able to improve the UK's debt dynamics and he will take some of the sting out of this criticism. The question is how does he do that? He obviously wants to lift, as he said, growth in every postcode and put hope in every heart around the country, but he has to deliver that growth. And what are the measures he'll take to do that? How fiscally expansionary will it be? Those are unanswered questions that obviously will matter a lot to the bond market as much as they matter to the UK economy What you say reminds me a lot of And here I will date myself, the United States in the early nineties where early in his presidency Bill Clinton famously moaned to his cabinet So what you're telling me is my successor failure as president depends on what the bond market does. They basically said, yes, mrter President, that's basically it But what happened was he got this great burst of growth that solved all these problems brought the budget deficit under control. calmed markets and it was just like he was a blessed figure I guess what I'm saying is there's only so much a national leader can do. to determine the ultimate question here. which is growth. Growth is the thing that ultimately gets you out of trouble What I'm reminded of in this circumstance is what John Madden said. He said Winning is the ultimate deodorant, which means whatever team, whatever problems your team has Who's arguing with who? this person hates that person. You can't work out this problem. If the team can just win, a lot of these problems or bad smells go away. Similarly, For governments, growth is the ultimate deodorant. much is forgiven if the economy can grow a little bit Certainly and then it's quite interesting he might then benefit, he would then benefit from some of the fiscal consolidation that's happened under this quite unpopular duo of our current Prime Minister, Sir Kist Stama and our Chancellor Rachel Reeves, where if he manages to continue with the fiscal consolidation and guilt issuance is expected to kind of come down a bit this year and he manages to get a bit of growth going, then you know, he can take benefit then he can take some credit for some of the decisions made in the past carry the good ones through and also leave things looking a lot better off. But yeah, like you say is whenever politicians take credit for interest rates, you think, there ares so many things that have outside of your control, the impact whether there a kind of interest rate rises or cuts. L how can a politician take credit for that? You mentioned how unpopular the current prime minister and his administration is And I want to end with a very broad question. which you may or may not be able to answer, but we can kind of feel around it Is the UK ungovernable? Is this succession of unpopular prime ministers symptoms of something structural that none of them can fix The reason I think this is important is because I see in what the UK is doing now a kind of glimpse of the American future Right? We haven't run up because of the position of our currency as you mentioned and other special advantages the US has. we haven't gotten into the stage of persistent repetitive fiscal crises. that you just mentioned, but it seems like we're headed for that Is the UK in a structurally difficult situation It just can't get out of no matter who the Prime minister is ust imagine the US if no one had to buy US treasuries this situation would be. and how it how it would all play out in that environment. Yeah, no, I can't tell. There would be flames billowing from the windows of buildings. peopleople would be running around in the streets with pitchforks And it would be an unbelievable nightmare. I care to contemplate it no longer Go on about the UK Yeah, I mean I think it's a really good question. I think it's a bit simplistic to say that the UK is unovernable. I think there are certain dynamics that are going to remain the same regardless of who's in number ten. You know, there are reasons why UK bond yields are high, inflation, a structural drop in demand from pension fund buyers and other dynamics that are shared. I think leadership does still matter. I still think you can design policies and inspire people But I do think what we have, the way I put it, is not ungovernable, but that we have this bad feedback loop in our politics between sometimes a fragile bond market and some of the debt dynamics that we've discussed on this podcast, and also our politics. And some people say is the UK more like Italy in times past, a succession of leaders failing to deal with the same kind of debt problem and like the rise of populists and that takes time to wash through. But I do think that political leaders can change things, maybe that I'm a hopeeless Maybe I'm a hopeless cant say. You can't. I it's all. Let me do it one more time. No I'm not gonna let that happen. You're trying to be optimistic and you can't do it because you're I can't bring myself to be optimistic without swallowing As my nite Brititionist, I'm afraid. All right. There you go. this as much as you get. Ian is trying to be optimistic. Let the record reflect. and we'll be right back with more optimistic or possibly pessimistic thoughts when we do long and short after. Listeners, welcome back This is long and short, or is it long or short? I can never remember. In any case, it's that part of the show where we go long things we like and short things we don't like And let me start at Ian with a topic that I know is close to your heart I am la every stock that is not a tech stock The magnificent seven is the magnificent seven now And semiconductor stocks are going sideways. we really need the rest of the market to take up the slack here. So I'm going long more in hope than incertainty You are calling the gry rotation. It doesn't happen until Rob says it is happening Where do you long at Sortian I am long Portugal national football team as I've just been given them in the office sweepstake for the World Cup. So I'll be hoping that Cristiano Ronaldo can finish his career with some glittering success on the world stage. On behalf of Middle A aged men everywhere, I hope you're right about Cristiano and the rest of the team. Listeners. We will be back in your ears on Thursday until then, stay cool