Markets need convincing on UK investment plans, says economist

Economist Jim O’Neill said markets still need convincing over the investment plans set out in Labour Chancellor Rachel Reeves’s first budget, after scepticism over her spending decisions helped drive up the UK’s borrowing costs last week.

“The whole thing is to boost investment spending but to make it better,” O’Neill said in an interview. “Are we suddenly supposed to believe that a £20bn spend on the NHS will be more productive than in the past? The market is showing some scepticism about that.”

O’Neill, a former Conservative Treasury minister under David Cameron who now sits as a neutral crossbench peer in the House of Lords, is a long-time advocate for changing Britain’s fiscal rules to allow for more borrowing for investment, which Reeves delivered in her budget on Wednesday.

He said Reeves could have allocated more investment to areas that the Office for Budget Responsibility would have viewed as likely to generate higher growth — such as further childcare provision to boost participation in the workforce — or vowed to put her investment plans through a process of expert advice to determine what would generate the best returns.

“Markets would’ve probably loved that,” said O’Neill, a Goldman Sachs Group Inc. veteran who advised Labour while they were in opposition on their plan for supporting startup businesses. “But because they’ve announced such a big increase on buildings for education and day-to-day spending in the NHS, markets are a bit suspicious.”

Reeves’ budget — which raised more than £40bn ($51.7bn) in extra taxes and announced £100bn of net public investment over the next five years — was met with a negative reaction by markets, with UK bonds, stocks and the pound all sliding amid concerns over the inflationary impact of the package and the prospect of interest rates staying higher for longer.

One of the disappointing aspects for Reeves was the OBR’s meagre growth projection, predicting the economy would be 0.1% smaller in 2029-30 than it had previously forecast in March under the former Conservative administration. The OBR blamed Reeves’ tax hikes, which included an increase in the national insurance payoll tax for employers that was criticized by many businesses.

The OBR also didn’t add a significant boost to its longer-term growth forecasts despite Labour’s £100 billion of capital spending. The OBR said that investment would only boost GDP by 0.5% in 10 years’ time, rising to 1.4% by 2073-74.

“It isn’t really big positive multiplier stuff,” O’Neill said of Labour’s investment plans. Spending on childcare or preventing infectious diseases would’ve generated bigger multipliers, he said.

The weak growth projections are a setback for Reeves and Prime Minister Keir Starmer, who emphasized the importance of economic growth during the election campaign. Both Reeves and Starmer had said tax increases beyond those set out in Labour’s manifesto wouldn’t be needed because extra spending on public services could be funded through higher tax receipts from higher growth.

Nevertheless, a group of economists including O’Neill wrote a co-signed letter in the Times newspaper on Saturday expressing support for Labour’s move to expand investment, but cautioned the money needed to be spent well.

“It is crucial that the independent oversight that the new chancellor has announced ensures new investment is targeted and cost-effective,’ wrote the economists, including Mohamed El-Erian, former deputy director of the International Monetary Fund, and Anton Muscatelli, chairman of the Royal Economic Society. “Such guardrails will ensure that rules are not ‘gamed’ and that joint investments with the private sector are good value for money.”

O’Neill told Bloomberg News he expected Reeves to have more to say about the government’s investment approach in due course. The Treasury has already indicated how it plans to improve the strategy and delivery of infrastructure projects by creating a new National Infrastructure and Service Transformation Authority (NISTA), and insists it will have “guardrails” over how public money is spent.

“I think we will see the new process around improving investments coming in the spring,” O’Neill said. “I do think the new framework will prove to be quite a positive thing for the UK.”

O’Neill also said it was “pretty wide of the mark” to compare the market reaction to Reeves’s plan to that which met the infamous mini-budget in 2022. The yield on benchmark 10-year gilts had risen 21 basis points to 4.45% by the end of the week, far off the roughly 100 basis-point move in the three days following former Prime Minister Liz Truss’s plan.