Not even three days of rioting in London can dispel the market's perception of the U.K. as one of the safest of safe havens right now. On the very day that Prime Minister David Cameron was forced to cut short his holiday to deal with the spread of looting across the country, the yield on 10-year U.K. government bonds hit record lows and the cost of insuring gilts fell below that of German sovereign debt. In a world of dysfunctional politics, investors see the U.K. as a beacon of stability.
The markets are betting the violence, while shocking, won't shake the government from its fiscal program. The riots seem to have less to do with the government's spending cuts than long-brewing social tensions in some London boroughs. The economic impact, while devastating for some local businesses that have seen shops destroyed, should be small overall. The British Retail Consortium estimates the damage caused could cost "tens of millions of pounds." The government may have to provide compensation to insurers for this, but that is a small price relative to its overall debt.
Meanwhile, the U.K. stands out relative to major economy peers in having a credible deficit reduction plan: The Treasury expects public sector net debt to fall below 70% of gross domestic product in fiscal year 2015-16. Ministers in the U.K.'s coalition government, its first for 70 years, remain committed to that plan, despite other disagreements. By contrast, successive European governments, and now the U.S. itself, have failed to convince markets and ratings agencies their debts are under control.
Still, the riots add to political strains in the U.K. Prominent institutions, including parliament, the media and police, have each suffered major scandals in the last 18 months. Opposition politicians may use the riots to strengthen their argument that spending cuts should be relaxed. Keeping the coalition together is already a challenge, with the junior Liberal Democrats sliding in opinion polls. The deficit reduction plan may be hard to stick to if U.K. growth continues to stall.
The riots are a warning that the U.K.'s apparent stability is not all that it seems.
Meanwhile, the U.K. stands out relative to major economy peers in having a credible deficit reduction plan: The Treasury expects public sector net debt to fall below 70% of gross domestic product in fiscal year 2015-16. Ministers in the U.K.'s coalition government, its first for 70 years, remain committed to that plan, despite other disagreements. By contrast, successive European governments, and now the U.S. itself, have failed to convince markets and ratings agencies their debts are under control.
Still, the riots add to political strains in the U.K. Prominent institutions, including parliament, the media and police, have each suffered major scandals in the last 18 months. Opposition politicians may use the riots to strengthen their argument that spending cuts should be relaxed. Keeping the coalition together is already a challenge, with the junior Liberal Democrats sliding in opinion polls. The deficit reduction plan may be hard to stick to if U.K. growth continues to stall.
The riots are a warning that the U.K.'s apparent stability is not all that it seems.
