The Reeves riddle: growth, bonds and democracy
The UK economy has everyone scratching their heads. At any one moment it seems both booming and busting. Inflation is running hot at 3.8 per cent, almost twice the Bank of England’s target of 2 per cent. Growth, however, has done better than expected. In the second quarter GDP rose by 0.3 per cent, down from 0.7 per cent in the first three months but well ahead of the 0.1 per cent most forecasters predicted. Services and construction did the heavy lifting, while business investment slumped 4 per cent and household spending dipped. On the numbers, the UK should be the fastest, or close to the fastest, growing economy in the G7.
Financial markets seem to agree. The FTSE 100 has climbed more than 12 per cent since January, setting new records above 9,000. Sterling has strengthened 11.3 per cent against the dollar this year.
Admittedly, the GDP figures were looking decidedly dodgy in April and May. The Chancellor’s jobs tax created a contraction that surprised Rachel Reeves and distorted the overall picture. Businesses were squeezed until the pips nearly squeaked, and consumer confidence along with business investment took a two-month hammering.
But June growth was far stronger than most economists expected, driven by services and a buoyant construction sector. Even retail, the laggard of the quarter, joined the party at the end. Many put this down to good weather. The real story was the jobs tax and the pressure it placed on employers’ bottom lines in April and May. By June that pressure had not disappeared, but it had been, if not absorbed, at least grimaced through. Uncomfortable, yes, but not, for most businesses, terminal.
This means June was not a growth blip but part of a wider long-term shift towards expansion in the UK economy, following on from Q1’s 0.7 per cent growth. The real blips were April and May, when the economy was uncomfortably digesting the Chancellor’s jobs tax.
Yet unemployment has risen to 4.7 per cent, its highest in four years, with over 200,000 more people out of work than a year ago. How can an economy growing at pace be shedding jobs? UK bonds (gilts) tell a harder story than unemployment. The 30-year yield stands at 5.42 per cent, the highest since 1998, while the 10-year is at 4.86 per cent, not seen since 2008. That means Rachel Reeves is paying far more just to service government debt.
The international establishment is equally baffled. At the start of the year the IMF forecast UK growth of just 1.1 per cent. Already the economy has grown by 1 per cent in the first half. The IMF has grudgingly lifted its forecast to 1.2 per cent, implying growth of only 0.2 per cent for the rest of 2025. Goldman Sachs is slightly more upbeat at 1.4 per cent. But essentially the consensus is that the British economy will flat-line for six months. They have been saying much the same for the last six months. The point is not simply that they have been wrong, but that they are looking through the wrong lens. Since the banking crisis of 2008, economists have repeatedly misread the UK, overestimating growth up to 2022 and underestimating it ever since.
Part of the rally in equities and sterling is capital fleeing the US, as investors seek refuge from the mess in Washington. Markets are broadly comfortable with Rachel Reeves, but when she falters in the Commons or struggles to impose her agenda despite a commanding majority, nerves fray. They may trust her instincts but they doubt her politics. Behind that unease lies the fear of a more radical successor.
Still, this does not explain the polarisation of the economy: rising unemployment, stagnant housing, rising gilt yields on one side; buoyant equities, GDP growth and a strong currency on the other.
The root cause of the contradiction is monetary tightening. Between 2008 and 2022 the Bank of England created £900 billion of electronic money to fight crisis after crisis. That money inflated assets, kept unemployment low and stopped businesses going to the wall, but at the cost of suppressed wages, productivity and growth. Since 2022 the Bank has reversed course, draining £100 billion a year through Quantitative Tightening. The pain is higher unemployment and a flat housing market. The gain will be stronger wages, productivity and long-term growth.
History does not repeat but it does echo. The politics of the Starmer administration could hardly be further from Thatcher’s in the early 1980s. But the economic parallels of Quantitative Tightening and its impact on the wider economy are the closest we have seen to Thatcherite monetarism: painful now, but laying foundations for renewal. The narrative around the policy, however, is completely different. Thatcher pursued monetarism openly and unapologetically, and fought an immense political battle over it. Her Cabinet was divided between monetarist hawks, such as Joseph, Lawson and Howe, who pushed high interest rates to crush inflation, and the wets, such as Prior and Heseltine, who warned of unemployment and social fracture. It was fought in public and in Parliament, as well as behind closed doors in Cabinet.
The impact of Quantitative Tightening is playing out in similar ways in the economy, but the public debate could not be more different. It is hidden, technocratic and barely acknowledged. Since the wreckage of Truss, the real guardrails of the UK economy have been set by the Bank of England and seem increasingly beyond the intellectual and technical reach of government, Parliament and therefore democratic mandate. Quantitative Tightening is pushing gilt yields higher, but the public narrative blames borrowing or government competence. It is pushing unemployment higher, but the same misguided narrative persists. The same goes for the housing market.
Democratic understanding of how the economy is working has declined and we’re now living in a technocratic age of economic management.
The Bank’s bond sales alone have added £30 billion to debt-servicing costs, against fiscal headroom of just £9 billion. That is the real driver of yields. Ministers cannot explain Quantitative Tightening in plain English, so they avoid it altogether. The result is the wrong story being told. Voters could understand. Politicians cannot, or will not, tell them.
Thatcher’s monetarism was explicit, contested and controversial. Today’s Quantitative Tightening is hidden, delivered by a central bank beyond democratic reach, while politicians tinker at the edges. The economy is not broken, but its narrative is confused. Until we are honest about where power lies, Britain will continue to stumble forward, sovereign in name but bound to the bond markets in practice.
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