Debt strategy will be the core of Reeves’s ‘aggressive’ budget

But its scale is now enormous. In total, Britain’s national debt nearly matches our national output, implying £111bn of annual interest payments – the government spends more only on the NHS, the state pension and education. Making sure the markets believe our debt is sound, and the interest secure, is a crucial policy objective.

It is a never-ending challenge. In stark terms, over this financial year, £170bn of government debt has matured or is maturing, all of which has had to be replaced by finding either the same or new buyers of freshly minted debt for another 10 or 20 years. And on top of that, buyers have to be found for up to £150bn of new debt to fund this year’s budget deficit.

The scale of the government’s annual demand for borrowing dwarfs how much we save annually, so overseas investors increasingly plug the gap – now reaching saturation point. Mark Carney, the former governor of the Bank of England and now the Canadian prime minister, famously declared that, in financial terms, the UK is dependent on the kindness of strangers. He was right.

The days of empire, industrial pre-eminence and sterling as a reserve currency are long over. Britain is a medium-sized economic power, an island in the North Sea. Nor does our economic performance both absolutely and in relation to others – on growth, inflation and productivity – offer buyers of our debt much reassurance.

The stock of Britain’s national debt may be in line with other advanced economies, but the interest it has to pay is significantly higher given the risks. Indeed, for a moment this year, the interest on 30-year debt was the highest for 25 years. Keeping its sceptical creditors on side inevitably looms large in the government’s budgetary calculations.

Enter the Debt Management Office (DMO), the organisation charged with managing our national debt and second only to the Office for Budgetary Responsibility (OBR) in importance to the budget process. Scarcely known outside the City, it has built an international reputation as being one of the most skilled and savvy managers of public debt globally.

Thus, one of the most important voices at the plethora of Treasury budget meetings is that of Jessica Pulay, its current chief executive. She has had a good October. Interest rates on 10-year government debt have fallen by about 0.3% to the lowest since January, which in any one financial year is worth £1bn a year in lower debt service costs.

The opinion of the DMO has always been influential in the Treasury, which in essence is a finance ministry dominated by financial bookkeeping and whose alpha and omega is keeping the bond markets on side. Information from the DMO’s City networks, along with Pulay’s canny assessment, would weigh heavily with what the chancellor needed to do and say to reassure the markets. So it has proved.

Just before Rachel Reeves attended the annual International Monetary Fund and World Bank meeting in October, Pulay, in a key meeting with the Treasury’s chief economic adviser, Sam Beckett, deliberated on a decision crucial to the character of the budget.

What should be the credible size of the multibillion-pound buffer – the supposed “fiscal headroom” – to guarantee to the markets that, even if the government was blown off course over the next five years, it was still probable there would be a budgetary surplus to meet its fiscal rule to lower debt in year five?

In Pulay’s judgment, the markets needed as a minimum to see a doubling of the safety margin to £20bn to offer a credible buffer – a scale of increase that must trigger tax rises.

Reeves took the message on board. Instead of talking about tax increases as something she would want to avoid as far as she could, her message at the IMF meeting was that Britain would cement a reputation for being an island of fiscal stability, telling reporters in off-the-record briefings she would aim to increase the fiscal headroom.

Higher taxes, and even spending cuts, had to be embraced. It was the trigger for the bond market rally that has lasted for the rest of the month.

For Britain is in an international fiscal beauty parade. The bond markets are aware that, 25 years ago, the UK ranked 21st in the league table for the relative size of its national debt to national output. Now the financial crisis, 14 years of consecutive deficits under the Conservatives, the Covid pandemic and Brexit have carried us up to fifth – with lots more risk.

If asked what more the government could and should do to reassure the markets over and above £20bn of fiscal headroom, Pulay will doubtless echo the view rehearsed by the Institute for Fiscal Studies’s authoritative Green Budget.

The bond markets like to see counter-inflation measures, containment of welfare spending and political capital spent on tax increases – especially an income tax increase. Removing VAT on energy bills falls in the first category; committing to revisiting welfare reform falls in the second; the mooted 2p rise in income tax, perhaps compensated by cuts in national insurance, falls in the third. Interestingly, all have been floated as leaks in the last week.

No 10 is increasingly concerned. Obviously, it recognises the need for “fiscal consolidation”, meeting the fiscal rules and assuring the markets. But it badly needs the budget simultaneously to entrench the government’s strategic objectives. Some insiders worry that what is emerging is a “bits and pieces” budget, vastly overdoing the views of the OBR and DMO.

The governing, overriding strategy has become delivering what the IMF confirms will be the most aggressive budgetary tightening in the G7.

There was an exasperated tone of reproach from the prime minister in his letter to the chancellor exonerating her over the house-letting licences affair.

He seems to have had the emerging shape of the budget as much as her personal lack of diligence on his mind.

Photograph by Jose Sarmento Matos/Bloomberg via Getty Images