The UK chancellor candidates have taken to the podium for a rare policy debate, and the City of London has been holding its breath. The pound sterling has been relatively stable against a basket of currencies, a sign of market confidence that, in the short term at least, fiscal responsibility will prevail. The debate pit the two frontrunners against each other on tax, spending, and the role of the state.
The hawks called for austerity, arguing that the UK's public finances are a ticking time bomb with debt-to-GDP ratios already at levels that would have made Gordon Brown blush. The doves, by contrast, attempted to lay out a Keynesian counter-argument, suggesting that now is the time to invest in infrastructure and 'levelling up' the north. But the markets were not buying it.
Gilt yields edged up, a clear indicator that investors are demanding a premium for the risk of fiscal profligacy. The fact is, the UK is a small, open economy with a massive current account deficit. Capital flight is a real risk.
The logic of efficiency tells us that any perception of the UK as a safe haven for capital is contingent on its adherence to sound money principles. The debate was devoid of any specific commitment to keep inflation in check. The candidates talked about 'growth' as if it were a magic wand, but anyone who has been in the Square Mile for more than a decade knows that growth without fiscal discipline is just a sugar rush.
The markets will be sifting through the transcripts. The real test, as always, will come with the first Budget. Until then, the City's stability is a vote of confidence that could be withdrawn at a moment's notice.
