Lloyd Harris argues it is important not to forget the tightrope we’re on since the pandemic.

With hindsight it was clear the UK was walking a tightrope when exiting the fiscal disaster that was the pandemic, much like many other countries. The ruling Conservative Party at the time briefly fell off when Liz Truss was allowed into office. However, there was an easy way back on to the tightrope because Truss and then Chancellor Kwasi Kwarteng were outliers in a party of largely fiscal conservatives. Truss and Kwarteng out, Rishi Sunak and Jeremy Hunt in the fiscally ultra-conservatives.

The balancing act was precarious for these replacements, but they were seemingly doing a pretty good job of navigating the tricky balance and getting to the other side, instilling sufficient private sector confidence. As a result, economic growth was starting to emerge. They were also clear that their objective was not big state but one in which a smaller state was accompanied by tax cuts when the time was appropriate. A shot, then, at fiscal sustainability and sufficient private sector confidence to drive growth because they were savvy enough to know they had to bring the private sector and the rest of the market with them.

Cue the election and the return of the Labour Party to power after a long absence. The promise was a business-friendly environment and a return to the 2.5% growth of the last Labour government back in the noughties. Unfortunately, Keir Starmer failed to spot that the global financial crisis (GFC) was a watershed moment for the UK and indeed many western economies. It was broadly the point at which the UK had reached the limit of private sector credit creation. A multi-decade, even multi-century process. It was this increase in credit creation that the last Labour government had used to fuel their 2.5% growth.

Things changed at the time of the GFC, though. Given the exhausted private sector leverage, any further build-up in debt had to be placed on to the state balance sheet. Then the pandemic hit, which blew public finances apart, and created sticky inflation. Growth from an increase in credit creation via the state is not possible anymore. This is the tightrope that Sunak and Hunt were on, and one which Keir and Rachel are only starting to realise exists.

Through the medium of the gilt market, they will come to the realisation of its existence because of the constraints imposed by both fiscal and private sector largesse of previous decades. The implication at present is that, through the Budget of October 30, they have already fallen off! At the Budget, Reeves risked creating stagflation, and she’s succeeded putting the UK’s debt dynamics on an unsustainable path. Growth was killed off by the Budget and recent increases in borrowing costs have been magnified. Private sector confidence, and therefore market confidence, has been smashed by the crushing tax rises of Rachel, and Keir has done very little to help matters – not willing to back his Chancellor in saying there will be no more tax rises, heaping even more uncertainty on the UK private sector.

Rising borrowing costs are one problem (every 50bp rise in gilt yields equals £6bn of extra interest cost over a 5-year forecast horizon), but growth is the major issue. £6bn is only 0.2% of GDP. With both sides of the debt-to-GDP formula going in the wrong direction, the Labour party needs to realise that private sector confidence is the solution to their present ills and that the state cannot provide the solution. Ideologically, this is a huge departure from the policies currently outlined by this Government and indeed would not sit well with the paymasters of the party. Rachel has maintained the line that she will not raise taxes more and run a balanced Budget, but surely when the unions are agitating for even more pay rises, austerity is actually going to be an impossible task.

In the immediate term, we expect there may be calls for the Budget to be reversed, because many feel private sector confidence is on its knees. There are already calls for the Chancellor to go. But could another Chancellor even undo the damage done? There is not an easy fix. It would require an ideological shift away from the big state. Without that, I believe we could see higher gilt yields and a lower pound, and no likelihood of getting back on the tightrope any time soon.