The Bond Vigilantes’ Shadow Over British Politics

The bond markets have become an all-too-familiar specter haunting British politics. Politicians warn about the wrath of investors who lend to the state, as if these creditors were a force beyond human control. Recent warnings from Chancellor Rachel Reeves and others about a leadership contest triggering a bond market backlash are just the latest manifestation of this phenomenon.

However, what’s often lost in this narrative is the role other actors play in shaping the bond vigilantes’ power. The Bank of England has significantly contributed to Britain’s high borrowing costs and the fear of bond markets by selling gilts on an unprecedented scale and ignoring global best practices on quantitative easing.

The Bank’s decision to sell £134 billion in gilts since 2022 is a telling example. This policy, dubbed “active QT,” was intended to combat inflationary pressures but had the unintended consequence of increasing government borrowing costs by as much as 0.7 percentage points. The so-called “Bailey premium” – named after Bank Governor Andrew Bailey – has been a major factor in driving up the UK’s borrowing costs.

Britain’s high borrowing costs can be attributed not only to bond market fears but also to the way our financial system is structured. Britain’s pension funds have become increasingly reliant on gilt bets with borrowed money, creating a toxic combination that threatens financial stability. When this bubble bursts, the Bank of England’s half-hearted interventions only serve to further destabilize the market.

Progressive politicians should stop worrying about bond vigilantes and start exploring alternative ways to finance big ambitions. This means scrutinizing the Bank of England’s policies and practices, eliminating inflation-linked bonds that force the UK government to compensate bond investors for higher inflation, and repurposing Britain’s pension funds.

If we continue down this path, we risk creating a “choiceless democracy,” where democratic mandates for change are vetoed by bond investors. This would be far from the kind of progressive government many voters expect.

One possible solution is to enlist the Bank of England in an orderly exit from linkers under a new framework for monetary-fiscal coordination. This would require a fundamental shift in our financial system’s operation, but it’s necessary for creating a more equitable and sustainable economy.

Britain is uniquely vulnerable to bond vigilantes’ power. With about a quarter of its bonds inflation-pegged – more than twice as many as Italy or France – the UK government has had to pay a staggering £153 billion in additional debt service since 2022.

The current impasse between central bank and government is reminiscent of the aftermath of Trussgate, where the Bank’s decisions amplified an existing problem in UK pension funds. The bond vigilantes’ power has been inflated by this process, creating a perfect storm that threatens the very fabric of our financial system.

To move forward, it’s essential to understand the intricate life of gilts and their influence on politics. This means having a clear-eyed understanding of what bond investors want – and communicating this with the public. It also means exploring alternative ways to finance big ambitions and creating a more equitable financial system.

The bond markets may be powerful, but they are not invincible. By taking control of our financial destiny and reining in the bond vigilantes’ power, we can create a brighter future for Britain – one guided by democratic principles rather than the whims of creditors.