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At pjum, we actively manage risk today while targeting outperformance tomorrow. So no matter what investment risks concern you most. From geopolitics to inflation to liquidity, PGM brings disciplined risk management expertise that spans 30 market cycles. Our active approach finds opportunities and volatility, helping our clients to navigate risk and achieve their long term goals. Pjum, our investments shape tomorrow. Today.
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Pushkin.
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The UK is building up to another budget. They seem to come around every five minutes and the next one is in November. But UK government bonds, or gilts to their friends, are already pretty weak and it would not take too much to weaken them further. Still, we all remember the Liz Truss mini budget from 2022 and the lesson was bonds matter. They can take down a government and whack up your mortgage costs in the blink of an eye. So today on the show, we're asking, can the Chancellor, Rachel Reeves, pull this off? How this is unhedged, the Markets and Finance podcast from the Financial Times and Pushkin. I'm Katie Martin, a markets columnist here at FT Towers in actually quite chilly London. And I'm joined in the studio today by a proper UK budget and central banking nerd, my colleague, Chris Giles. Yes, people, today's show is an American free zone. And relax. Chris, thanks so much for being here. It's a real pleasure Budget day. It's a biggie for the ft, it's a big one for the UK government, but it's a bit of a kind of like set piece, almost ceremonial event that I don't think foreigners understand, like, what's the deal with the budget?
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So on budget day, the Chancellor comes out of 11 Downing Street. The prime minister, of course, is in 10 Downing street, the next door house, and holds up a big red box. Now, traditionally it was a box from in the mid 19th century, a sort of 1850s red box. It's like a briefcase, but made of wood and small. And the budget speech is in there and the Chancellor comes out of the door, holds it up, all the press take pictures and shout at the Chancellor and say, what's in the box? What's in the box? And then he or she goes to the House of Commons and then opens the box and reads it out, also the Chancellor. So one time when delivering a speech in the House of Commons, any MP is allowed to drink alcohol. And so, oh, fab. We used to have quite fun Chancellors who would have a large glass of whisky as they were reading out the budget. But that has not happened, I don't think, since Ken Clark in the mid-1900s.
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C
It's gotta be Ken Clark, hasn't it, realistically. But yeah, there is quite a lot of sort of pantomime about this whole thing.
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It's great.
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C
Yeah. You do love it. We all love it, really.
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B
So the Chancellor, who's the finance minister in other countries, he or she now it's a she will read it out and basically what is announced on the day will get legislated for. This is where the UK is really different. There's no debates in Parliament.
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C
Right.
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B
It will go through. It's a big set piece. Because the way that Parliament works is as long as your party has a majority, that will happen. And so all the tax changes, which are supposedly secret in the run up to it, there's no debate in the country then get announced on one day.
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C
And that happens just also to sort of set the scene a little bit, it's often said that the UK wants Nordic style public services, but with like super low tax rates. Is that a reasonable representation? Do we want an awful lot more for our money than we can really have?
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B
Absolutely. So we want European style public services. So we have those essentially in our budgetary system. So we have free health care, we have an extensive welfare status, extensive Social Security system, so pensions and other benefits. If things go wrong in your life, preschooling, all of this, you get all quite expensive stuff. And yet our taxes are generally, they're not as low as those in the us, but they're towards the bottom end of the international league table. And in some areas they're really low. So for people on average earnings, direct taxes coming out of your pay packet are pretty much close to the bottom of similar countries because we have a big tax free element in your pay and not very high income tax rate. So a 20% rate plus then you need to pay national insurance, which is another sort of income tax. Oh, I'm gonna forget about 8% or so.
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C
Right, right. And the government, it's been in power for little over a year now, but it's painted itself into quite a corner. So in the run up to the last general election that it won, it promised, put it in its manifesto, solemn, solemn, solemnly promised not to raise personal taxes. This rules out a whole bunch of actually very useful, really easy to introduce tax rises. Can't do that. And it tried raising taxes on employers in the last budget, which it did, and that's turned out to actually be bad for jobs. On the flip side of that, like, the Labour government's got a massive majority, 155, I think I'm right in saying, and politically it cannot push through spending cuts that it needs in easily deliverable ways. Meanwhile, it's effectively maxed out its credit card. Right. It cannot borrow much more from bond investors without paying a much, much higher borrowing cost, which would hurt growth. So. Checkmate. So what on earth does Rachel Reeves do here to square this circle?
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What gives? Well, it's difficult and it's really difficult because as you say, the tight spot is that she's ruled out all the sensible ways of raising tax, which would completely get the money that she needs for the spending plans. So. And the fact that debt, interest costs more than it, it used to and in lots of countries, not just, not just the uk. So the particular problem she's got this year, last year there was just a whole bunch of clearing up the mess that the previous government left it. That's, I'm not just being nasty to the last government. There was a bunch of strikes, there were things that weren't in the budget, like asylum systems costs and all things which had been sort of brushed under a big carpet all got put out into the open. And so there was quite a lot of money they had to raise not very effectively then and now this year the problem is different. We have an independent forecasting body called the Office for Budget Responsibility, which we know because it's basically. They're independent, but they're basically pretty public and upfront about things. We know that they're going to cut the growth forecast for the UK economy over the next five years, not because they think this government is doing anything particularly bad, but because for the last 15 years they've assumed that medium term growth is going to be stronger than it's been. And they're now sort of come to the end. They say they're at the end of the road.
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C
Right.
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They can't always assume that. It's just going to get back to the pre global financial crisis. So this is obviously very difficult for this government because this is coming and the OBI is right to change the growth forecast because everyone in the private sector thinks it's too high as well. So they're going to bring it down. And the trouble is the moment you bring the growth forecast down, your deficit forecast rises because you can't assume you'll collect as much tax just through growth.
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And we've got quite sticky inflation, which means that borrowing costs are high.
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Although sticky inflation helps tax revenues, I guess. So, you know, these things are complicated, but there will be a hole. So it's not that the UK government has run out of road. It's got a plan to get borrowing down, but by the end of five years it knows it's going to get a nasty forecast revision. Then it needs to either raise taxes or cut spending to bring those numbers back into line. So you don't need the money raised this year. It's not necessarily money out of people's pockets or in more taxes on spending this year, but to make the books basically balance by the end of the decade. So five years away, that is what the plan is. And so they're making up that hole. So that hole might be made up with tax increases or spending cuts that come quite late. They might be 28, 20, 29 or so, or they might decide to do it immediately. And that's the sort of theatre and drama of budget day. What we're going to get, the two things we don't know is exactly how much and exactly when. And so that's, that's what we're sort of all quite excited about.
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C
So when I talk to bond investors, they all say they are like they're laser focused on, on this budget. Because the UK is a bit of a test case, right? If, if we can't figure out how to square this circle when we've got a massive majority in Parliament for the party that's in charge, then there's no hope for France. The certainly, you know, there's no hope for, for the us. You know, the Brits have kind of got to make this work. Plus the UK government bond markets, gilts, we, we did go through the ringer like just, just a few years ago now. So right now gilts are pretty weak, which means that yields are up on the 10 year gilt at about the same level as they were in 2008. So we've got quite weak government bonds. But what's notable to me is that they are not falling particularly further in the immediate run up to the budget next month. And Sterling is doing kind of fine against the dollar. So that I think is the market's way of saying, right, listen lads, game's up here. We know you're going to break your promise and raise taxes. Let's just get this all over and done with. Because if the market thought there was any chance that Rachel Reeves would find her way out of this situation by just borrowing more, then guilt would be getting fried.
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Oh, absolutely. And there is no way that she's just going to borrow more. So the big question is, is she going to be faced with having to raise like a really Large amount of money, so sort of in the 40 to 50 billion pounds. Now, if you think about UK GDP, I was just going to do some maths on air here is, so UK GDP is roughly 2,500 billion. So 25 billion is 1% of GDP.
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So that's quick maths, kids.
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So that is the sort of number you want to think about. By the end of the decade, it will be more like 3,000, GDP will be more like 3,000 billion pounds a year. So if it's a number like 30 billion, that's like 1% of GDP, which incidentally is roughly similar to what Trump is raising in the US through tariffs. So that's. It's that sort of size of tax increase that we're looking at. Just to put things in, in perspective that that is chunky, but it's not desperate. You know, you can raise 1% of GDP and that's the sort of number I think is likely to come. I think it's more likely to come in a whole bunch of small things, because that would be much more sensible just to do some things. And that's. You'll be guaranteed you get your money, then they will get accused of breaking their manifesto. So I think they might well do the piecemeal effect, which will be very difficult. And then there'll be loads and loads of people who think that they're being unfairly targeted for tax increases and get really, really cross, even though basically everyone is paying.
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I mean, opinions differ here, right? But, like, to what extent is the bond market a constraint on what the government does?
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Oh, it's clearly a huge constraint, and quite rightly so, because the UK has debt very similar to the US, close to 100% of GDP. The UK does not want to default on its debt. That would be bad, which would be really bad. And so the price it has to pay is a very, very relevant thing for the UK to think about. So what is it paying now? It's paying roughly 3% of GDP on debt, about 100,000,000 billion pounds a year. That's gone up a lot because interest rates are much higher than they were in 2021. But even though there's been a lot of focus on, like, UK borrowing costs getting more expensive at the long end. So 20 to 30 to 50 years of borrowing, actually, that's not making the overall cost go up because the UK is not issuing any of. It's issuing a little bit, but very little of that debt these days. So this year, the average borrowing cost of the UK government is 4.3%, I think I heard the head of the debt, the Debt Management Office, say the other day, and last year it was 4.2%.
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Right.
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So let's not get too right, okay? Worried about everything getting way more expensive because they're changing how they're financing the deficit, but they're doing that because there are bond investors out there or people who invest in the UK bond market and we need to borrow that money. You can't just say, and you can't make them buy.
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You can't hold a gun to their.
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Head, you can't make them borrow. So you could ask the bank of England to buy it for you, which they could, but then you might have a bit of an inflation problem on your hands. So it's not that they are in control, but they're in the background and what you want is them never to be in the foreground. So you make all the political decisions you've got with some constraints in the background, and then that is fine. That's completely democratic. Every government is, even the US has to think about what its investors are thinking. And that doesn't mean that they control policy, it just means that you can't do something really dumb. And that's quite helpful for you as a politician to have a constraint to stop you doing something really dumb.
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C
There's some sort of electric fence around you to stop you doing super, super stupid stuff. What I gather is that the sort of brains trust behind this new budget that's coming out next month, their priority is to make this as boring as possible. Right. And to. And absolutely not to upset the gilts market because they saw what happened to Liz Truss and just because generally it's bad to weaken UK government bonds because that pushes up borrowing costs not just for the government, but also in everybody's mortgages and all the rest of it. Do you think they will manage to pick a boring path through this?
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I think one of the problems is that there is so much focus on this and there's so much speculation in advance that this is never boring. And there's so much speculation in advance in the UK precisely because there's. The moment it's happened is basically done. It's legislated immediately.
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C
What's the date on it again?
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26Th.
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26Th.
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So everyone has their big debate when they don't even know what they're talking about.
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Right.
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Because these things are kept really quite secret. Yes, some things do leak, but not that much. There'll be a lot we don't know going up to the day and then every financial advisor tries to get business off their clients, saying, oh, you worry about this. Maybe you should take this action in advance. It's all terrible. This is all a really, really dumb way to set fiscal policy, but it is the way the UK has done it since 18 something or other. And it's not going to change because it's. The Finance Ministry loves it as a piece of political theatre.
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It's. It's a dom bit of political theatre, but it's our bit of political theatre.
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And we're the only ones who do it in this much of a stupid way.
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So everyone else just going to have to put up with it.
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Yeah.
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Let me ask you really quickly. UK politics is an interesting place at the moment. What the party that's doing really well in the polls is Nigel Farage's Reform Party. We're still a long way away from a general election to select a new government, but do we have any clear sense of what reform would do with stuff like budgets were it to get in?
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Not really. What they've said keeps changing. And I think it keeps changing in an interesting way, which is it keeps getting slightly more realistic.
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Right.
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Which shows that they are thinking about getting into power.
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I think.
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So there was a time when they would just promise lots and lots of tax cuts and then have some weird and hand wavy spending cuts. Then they would say they would cut taxes and then they would make sure that immigrants didn't get any money from the state and that's how they'd pay for it. Now they're beginning to drop the tax cuts because I think they're realizing that having very certain policies that increase borrowing, borrowing and your country's debt and essentially spending cuts which might well not happen or not credible is not good. And the bond markets will start to look at it and that would be a disaster come in an election campaign. If it came to be seen that if this party won the election, then we were going to have a financial crisis on our hands. They will want to stop that. And so they're still terribly vague, but they are beginning to move in what people would say a conventional or sensible.
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Yeah.
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Or at least making it clear that they understand some of the constraints which they have in the past not had to do because they were never going to get into power.
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Yeah. They've got a lot of the same constraints as Rachel Reeves.
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Oh, everyone has this. This is the country's constraints. It's not a political party's constraints. And anyone who's in power would have to deal with that. And if you. And again, if you want to just say, okay, we'll just cut spending. Well, you have to identify who won't get some of the services which British people really like getting. So just like in America, they have to say to people, your Medicare bills might go up an enormous amount, which was not going to be popular. These constraints, the amount of money there is, as Elon Musk found with Doge in just cutting woke stuff or inefficiencies, is tiny relative to government budgets. And so there just isn't a magic pot of money money out, out there somewhere.
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C
If any listeners out there do know where that magic piece of money is, please let us know. We would love to know. Chris, thank you for that whistle stop tour through the budget. We're going to be back in just one second with Long Short. Alrighty now it's time for Long Short, that part of the show where we go long a thing we love or short a thing we hate. Chris, before we get into it, we are both super fans of Da Da Da, the Traitors.
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It's brilliant, it's just fantastic.
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There's a large part of like, of the ft, like the staff inside the building who are totally obsessed with this thing.
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It's the best reality TV there is around.
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The best, the campest, the most ridiculous reality TV around. Totally, totally love it. But what else are you long or short of?
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Well, I'm going to go short of the International Monetary Fund. Its relevance in the world is really quite low, even though everyone's going over to the Washington bureaus this week and it's lent so much of its money to Argentina. It really should be called the Argentina Monetary Fund from now on.
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The amf. You heard it here first, folks. I am short of not Dubai as such, but I'm sure of people telling me they're going to move to Dubai because the UK is so over and taxes are so high that they're going to move to Dubai, banging on about it, but then very conspicuously not moving to Dubai and continuing to go on about it from London.
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It's just. It's whinges really, isn't it?
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It's whinges. I'm here to tell the whinges. I checked earlier. The flights to Dubai go From Heathrow, terminals 3 and 5. The Lizzy Line will get you to the airport nice and swiftly. Off you go. Have a very nice time. Please stop going on about it. That's what I'm short of.
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B
I'm sure they'll listen to you.
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Yes, they so often do listeners. We will be back in your ears on Thursday without Chris this time. But Chris, thanks again. So on Thursday, listen up then. Unhedged is produced by Jake Harper and edited by Bryant Urstadt. Our Executive producer is Jacob Goldstein. Topher forges is the FT's acting co head of Audio. Special thanks to Laura Clark, Alastair Mackey, Greta Cohn and Natalie Sadler. FT Premium subscribers can get the Unhedged newsletter for free. A 30 day free trial is available to everyone else. Just go to ft.com unhedged offer I'm Katie Martin. Thanks for listening.
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Ra.