Macro Moments Weekly: No More Free Lunches—A Bond Story

Key takeaways

• Bond markets are pushing back. Years of rising government debt and higher borrowing costs have left governments with less room to manoeuvre, putting greater pressure on fiscal credibility.
• Tax rises alone won't solve the UK's growth problem. With borrowing constrained and further taxation potentially counterproductive, stimulating investment and improving productivity are becoming increasingly important.
• The housing market illustrates the challenge. High mortgage rates, rising construction costs and regulatory pressures are weighing on housebuilding, complicating the government's efforts to revive growth ahead of the Autumn Budget.

The message from the bond markets is simple: “No more.” They are exhausted. After being tapped for cash during the global financial crisis of 2008–2009, the slow growth of the 2010s and the debt explosion around the COVID-19 pandemic, bond markets appear to have reached their limit. At the same time, global central banks have embarked on a new cycle of raising interest rates. While inflation persistently hovers around the 3% to 4% level, it may not be long until your bank savings account earns more than inflation. Real interest rates that really cost people will also change their economic behaviour.

We have been here before. During the hyperinflation of the 1970s, interest rates remained deliberately below the inflation rate. Economic policy was directed at full employment—the children of the unemployed from the 1930s, now in power, were determined to prevent the hardship of the Great Depression from recurring by putting people to work. At the same time, in the United Kingdom, the mortgage market was reformed, leading to an explosion of lending and house buying. As long as a homeowner’s mortgage interest rate was below inflation and wage increases were above it, they were better off. For the vast majority, this was the case, and inflation effectively destroyed the value of their mortgages. Great—except the government lost the confidence of the markets.  Government spending was rising faster than inflation, but tax receipts were not keeping pace. Investors stopped lending, saying “NO MORE” via a collapse in the currency and falling bond markets. The United Kingdom went to the International Monetary Fund for help when the debt-to-GDP ratio was just 46%. Today, it is 93%.

But the message from the market today is, once again, no more. Government policy must somehow promote growth with no more money to spend. Raise taxes, perhaps? Or introduce a wealth tax? The history of wealth taxes is not good. In 1982, France’s socialist President François Mitterrand introduced the ‘impot sur la fortune,’ which translates to ‘the solidarity tax on wealth’. It was charged on individuals with a net worth of more than €1.3 million at 0.5% of assets, rising to 1.5% over €10 million. It was abolished in 1986 but resurrected for a few more years until it was finally revoked in 2017. Although it hit some 342,000 households by 2015, it raised only €5.2 billion, of a total tax take of €1.1 trillion.

However, there were consequences—it led to 60,000 millionaires leaving the country between 2000 and 2016, and French economist Éric Pichet estimated the tax had cost twice what it raised. Would it be better to raise the top rate of income tax instead? President Hollande tried that in 2012, where his short-lived 75% on earnings above €1 million led to the threat of a footballers’ strike, and Bernard Arnault, the creator of LVMH, took Belgian citizenship. It wound up being repealed by then-Economy Minister Emmanuel Macron, who said it made France into ‘Cuba without the sun.’

So, if you cannot stimulate demand through borrowing, if taxation is banging up against the Laffer curve and wealth taxes do not work, how does a government fill its coffers via growth? Back to the supply side, of course. In the 1980s, high taxes, poorly managed state companies and controlled markets were replaced by deregulation and tax reduction, but today it seems that the UK suffers from an investment impasse and poor productivity growth that has limited real wage rises.

The challenge is to promote investment, especially in the housing sector, where high mortgage interest rates are hurting demand, and high building costs—driven by both materials and regulations—have reduced supply. While the year isn’t quite over, in 2026, it is estimated that new house building will have fallen by about a third. It's about to get worse. This past week, Taylor Wimpey, one of the United Kingdom’s largest quoted housebuilders, announced it was pulling out of London completely. Vistry has already said it will cap output at levels well below its peak, and Berkeley Homes is not buying more land.

All this is on the desk of John Healey in the run-up to his first budget on 28 October. Alongside stimulating investment, he needs to find the cash to fund an increase in defence spending as well as social care. All with against backdrop of the bond markets saying, “No More!”

As former Prime Minister Liz Truss found when she went for 1980s-style tax cuts and supply-side reforms, the bond markets can cost you your job. The stakes could not be higher.

Parting shot

As I have focused on bonds for the last two weeks, it seems fitting to point out that the new James Bond will be announced by the end of the year. As it has been five years since the release of the last Bond film, speculation on who will replace the legendary hero is now reaching fever pitch. There are three names in the frame: Jack Lowden (River Cartwright in Slow Horses), Callum Turner (Eternity, and recently married Dua Lipa) and Jack Barton (Heartstopper and SAS Rogue Heroes). If Lowden were to be chosen, he would be the eighth Bond and the first Scot since Sean Connery. On the other hand, if Callum Turner were to be successful, would Dua Lipa write the theme song?