As the Conservative leadership contest enters its final stretch, the next prime minister inherits an economy teetering on the edge of a fiscal precipice. The bond market has been restless: the 10-year gilt yield has lurched above 2.2 per cent, a level that would have been unthinkable during the era of quantitative easing. This is the price of political uncertainty, and the market is demanding a premium for it.
Let us be clear: the era of cheap money is over. The Bank of England's rate hikes have been a belated admission that inflation is not transitory but a stubborn, embedded feature of the post-pandemic landscape. Headline CPI may have eased from its double-digit peaks, but core inflation remains sticky at over 5 per cent. The new occupant of Number 10 must confront the reality that the era of fiscal largesse is done. The Truss-Kwarteng experiment in unfunded tax cuts was a cautionary tale: the gilt market revolt and sterling crash of September 2022 are scars that will not heal quickly.
The next PM must restore credibility. That means a credible plan to reduce the deficit. The Institute for Fiscal Studies has warned that public finances are on an unsustainable path, with debt interest payments swallowing over 10 per cent of tax revenues. This is not sustainable. The next government will have to make tough choices on spending or taxes, likely both. The market will not tolerate another bout of fiscal incontinence. Capital flight is a real risk: foreign investors hold over a quarter of UK government debt, and their patience is finite.
Then there is the productivity puzzle. British output per hour has stagnated for a decade, lagging behind the US and Germany. The next PM must focus on supply-side reforms: planning liberalisation, skills investment, and a sensible industrial strategy that does not pick winners but creates the conditions for private sector growth. The Chancellor's Mansion House speech this week hinted at pension fund reform to unlock capital for infrastructure. Good. But the devil is in the detail.
The biggest elephant in the room is net zero. The transition to a low-carbon economy will require vast investment, but the government must ensure it does not become a drag on competitiveness. The carbon price floor and renewable levies are already adding to energy costs for manufacturers. A smart approach would be to use carbon pricing revenues to cut distortionary taxes on labour and investment. That would be fiscal discipline with a purpose.
Finally, the next PM must grapple with the consequences of Brexit. The Office for Budget Responsibility estimates that leaving the EU has reduced long-run productivity by 4 per cent. The new government cannot reverse this, but it can mitigate the damage by reducing trade frictions and improving regulatory agility. A more flexible, dynamic economy is the best way to offset the loss of single market access.
The bottom line is this: the next PM will face a harsh reality. The days of big spending and low taxes are over. The market is watching. The gilt market will not be fooled by rhetoric. Only a credible plan for fiscal sustainability, combined with supply-side reforms to boost productivity, will restore confidence. British fiscal discipline has been the bedrock of our economic stability for centuries. It must remain so.
