The economic turmoil in the UK over the past few weeks has been extraordinary to watch. It was triggered by the mini-budget and a fear that the Tory government’s economic sums did not add up. But it has been coming since Brexit and the political and economic upheavals that followed.
The game is now being played in a changed world. Interest rates and inflation are rising, governments no longer have access to borrowings at zero or near-zero interest rates, and post-Brexit Britain is not the flavour of the month.
For the low-inflation years after the financial crash, and then through Covid-19, governments – including our own – have been able to borrow at extraordinarily low interest rates. Now inflation is back, interest rates are on the rise, and bond investors are again assessing which countries they want to lend to and on what terms.
If the markets are going to demand a higher interest rate from the UK to lend it money, then this will cost not only the state but all borrowers, including mortgage holders
The really scary thing about what happened in the UK was not the fall in the value of sterling, dramatic though that was. It was the jump in long-term interest rates: the cost of long-term UK government borrowings rose from around 3.2 per cent just before the budget to close to 4.5 per cent afterwards. In bond markets, this speed of change is rarely seen. In the UK’s case, however, these sudden moves reflect policy choices made over a period of years – and the ill-judged mini-budget was the catalyst.
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If the markets are going to demand a higher interest rate from the UK to lend it money, then this will cost not only the state but all borrowers, including mortgage holders. Investors will remain nervous because they are not sure whether policy is being driven by some incoherent far-right Tory agenda, replete with policy contradictions, or whether it might eventually move back to the calmer waters of old-style Conservatism.
And this goes further than financial investment – the post-budget uncertainties on trade and regulatory rules are an issue for foreign direct investment as well. If you are in a highly regulated sector such as pharma, for example, you need to know what rules you’ll have to play by.
Steady and boring plays better than dramatic “pro-growth” policy lurches. Stability counts for a lot. What has happened in the UK – requiring a dramatic intervention by the Bank of England – is the opposite of this. It undermines credibility, and immediately leads to a hundred other questions being asked. Keeping out of the spotlight is a much better strategy.
Ireland had its own falling-out with the bond markets after the 2008 financial crash. Again, it was a problem – or a series of problems – which had built up over many years, hidden in plain sight, all based on soaring property values. Seemingly profitable banks were, in fact, shaky. Soaring tax revenues were vulnerable because of their over-reliance on property transactions – and on corporation tax, which was then just a quarter of today’s levels. The former Celtic Tiger was on the front page of the European papers for all the wrong reasons.
Scarred by this experience, Irish government policy went into ultraconservative mode. We have majored on steady and stable. This has allowed the State to borrow money cheaply for years. And the associated economic stability has helped to attract a rake of foreign direct investment.
Significant threat
Ironically, it is the fallout from a big post-financial crash surge in foreign direct investment which offers both a huge financial advantage and a significant threat. The ongoing rise in corporate tax receipts is a big cushion for the exchequer – and it could keep going for another year or two, as more profits are exposed to tax here due to tax allowances running out on key assets moved here after 2015.
But corporation tax now accounts for more than a quarter of all revenue – and remember that a key conclusion after the financial crash was that Ireland’s reliance on cyclical revenues was one of the big mistakes. In 2008, corporation tax, capital gains tax and stamp duty together accounted for 30 per cent of tax revenues. By the end of this year, corporation tax alone may not be too far off this figure.
This is Ireland’s biggest financial exposure. A fall-off in corporation tax would threaten to upend the strategy of beating the budget targets each year. While for years the focus was on international tax reform as the key risk, now the bigger consideration is problems hitting particular sectors, or companies.
The lesson from the UK is the high price for borrowing that can now be demanded again if a country’s public finances do not look solid
And while we talk about ten companies being responsible for half of all tax revenues, the truth is that four or five are paying the bulk. That leaves Ireland reliant on the fortunes of a handful of big companies such as Alphabet (formerly Google), Apple, Meta (formerly Facebook) and a few large pharma players, at a time of significant international economic uncertainty. Adding two and two together would suggest that Apple, in particular, is one of the big contributors to this year’s surge.
Bond markets sniff out weaknesses. In the case of the UK, the price of the crazy economic course which began with Brexit was laid bare in recent weeks, with huge consequences. For Ireland, the reliance on corporate tax is by far the most obvious risk. Without the frothy bit of this revenue‚ the Department of Finance calculates that an expected €1 billion surplus this year turns into an €8 billion deficit.
The lesson from the UK is the high price for borrowing that can now be demanded again if a country’s public finances do not look solid. The era of low inflation and low interest rates is gone. Given our reliance on one key revenue source, Ireland cannot afford to be too smug looking at the UK’s economic woes. Putting some of this money aside in a national reserve fund is a start, but much of Irish politics, both national and local, is still based on the dangerous assumption that the money will keep rolling in.