Oral evidence: Budget 2026, HC 682

Oral evidence, 14 October 2026.

Witnesses

Lord O’Neill of Gatley, Dr Peder Beck-Friis and Professor Anna Valero.

Chair

Welcome to the Treasury Committee on Wednesday 14 October 2026. Today we are beginning our evidence sessions ahead of the Budget on 28 October. Today we have some eminent economists in front of us to talk about what challenges and options the Chancellor of the Exchequer is facing as he finalises that Budget. I am really pleased to welcome back Dr Peder Beck-Friis, who is the senior vice president and economist at PIMCO. Welcome to Lord Jim O’Neill of Gatley, who is, as we know, a very well-known senior economist and often in the media, and was also Commercial Secretary to the Treasury. I believe that Lord O’Neill was offered a job under the current Prime Minister but chose to stay outside Government. Is that a fair summary?

Lord O’Neill

Apparently.

Chair

It is fair to say that you are probably making waves whether you are in or out of Government. Then we have Professor Anna Valero, who is a former adviser to the last Chancellor of the Exchequer, Rachel Reeves MP, and is also now director of the growth programme at the Centre for Economic Performance at the London School of Economics and Political Science. A warm welcome to you, Professor Valero, on your first time at this Committee.

John Glen

I would like to start by getting all of your assessments of the state of the economy and your views on its situation now, given what has happened with the Iran war. We now see 10-year gilts at 5.41% and 30-year gilts at 5.88%; they topped 6% for the first time since 1998. What is your overall assessment of the state of the UK economy?

Dr Beck-Friis

We have been surprised by the resilience of the UK economy, but it is important to put this in a global context. Growth has been strong everywhere since the start of the year, so in the US, Asia, Japan and most of Europe. Even Germany, which has been in a very long recession, picked up at the start of the year. This is nothing, in our mind, that is UK-specific. There are global drivers behind this, but of course it has been surprising in the context of the war. In particular, it has been surprising in the UK given the state of the labour market and the fact that fiscal policy here is tight. In most other countries it is neutral or loose. What is the main source of resilience? AI is clearly part of that story. It is showing up in two ways. First is investment spending. We are in the midst of a global capex boom. We have seen this in Europe, but it is clearly concentrated in the US and Asia. That is spilling over into strong exports across the world. Secondly, it is showing up in higher equity prices, and in asset prices more broadly. That means that consumers in general have continued to spend. Even though interest rates have increased, broader financial conditions have not tightened that much in the context of higher asset prices. In our outlook, there is a tremendous amount of uncertainty. We need to be humble. There are a lot of upside and downside risks, but the baseline is that this resilience will continue. It is easy to think of downside risk in the context of AI spending, uncertainty around energy prices and uncertainty around financial conditions.

John Glen

Can I follow up on that? A new assessment was made by the IMF yesterday about UK growth of 1.2% for 2027, set against the OBR’s March expectation of 1.6% for 2027. Could I draw you to comment on what you think the outlook is for next year and whether you see this resilience continuing, given what we see in the markets?

Dr Beck-Friis

Our baseline view is that growth will be slightly above 1%, not 1.6%—that would not be our baseline outlook—but that the resilience continues. We tend to think that UK trend growth is somewhere around 1%, or perhaps a little higher, so next year trend line growth perhaps slightly stronger.

John Glen

What is the reason for the OBR’s optimistic perspective?

Dr Beck-Friis

It has been optimistic for many years. It downgraded productivity growth last year, so that was marked to market to what the sell side and the private sector were expecting. There has been a slowdown in UK trend growth over the last few decades, and it takes a long time for forecasters to update their assumptions. If you look at growth in the UK over the last few years, it has been fairly soft around 1%. It is not 0%, but it is not like the US growth of 2%. Forecasting is very difficult. A baseline is to extrapolate what the recent trend is. If that has been around 1%, I think that is a fair baseline to start with.

Lord O’Neill

I agree especially with the earlier parts of that. One of the many fascinating things to me is that, I think, growth over the first half of the year is actually running in excess of 2%. Even when I point that out to people around this part of the world, and many others, they either do not believe it or dispute it. It is possibly a consequence of growth having disappointed for so long.

John Glen

Have we seen a phenomenon, though, of higher growth in Q1 and Q2?

Lord O’Neill

Part of the sell-side community is taking it for granted that that is some kind of bad thing going on with the seasonals. Whether it might be, who knows? Thank God I do not have to do the forecasting thing I once had to do for so long.

John Glen

Sorry for asking you.

Lord O’Neill

I do not dismiss the possibility that, in this case, the consensus has got it wrong. As you touched on, most importantly—I am sure Anna will talk about it more—the productivity numbers have finally started to improve, just when, amusingly, the OBR gave up on that ever being possible, even without the revisions to the mainstream calculation. It could be something of more substance. I will maybe come back to this, but one thing on which I have a somewhat outside-consensus view is that it is not impossible that some of that has nothing to do with AI, and that it is because the national insurance surcharge increase was such a shock to employers that it has indirectly kicked off some steps that boost productivity. It is quite feasible that that might be happening.

John Glen

Could I draw you into the other things around the gilt rates and so on? We acknowledge that there are global factors at play, but underlying inflationary pressures are still high as well. How do you see that interacting with the phenomenon you have just talked about, which is, in essence, not hiring as many people and using labour more efficiently because of the cost of bringing in new labour?

Lord O’Neill

Here is the expert for the gilt market, I guess. It is worth emphasising, and I recently looked at it again a bit more closely. We are post the IMF forecast, which also gave it a lot of attention. It is not obvious to me that the gilt market is necessarily being penalised because of our relative shifts in fiscal things, although—I contradict myself—the absolute level of where our yields are obviously has something to do with it. From the last time I looked, which I think was Friday, our gilt market has not been hurt as much as any other G7 bond market over the past year. When I delve into it with my own analysis, not so intensely as I once would, I think it is something more to do with the inflation outlook, inflation expectations and, crucially, the market assumption for the profile of the Bank of England, at least from a cyclical perspective. That would be my guess.

John Glen

Could I ask you the same question about your view on 2027 and the views of the OBR and the IMF? Where do you see things rolling forward to next year?

Lord O’Neill

Linked to how I answered the first question, I do not dismiss the possibility that the OBR might be right. As it relates to other things we are going to get into, the most important thing for me, from a cyclical or tactical perspective, is that this Budget does not screw any of it up, because it has been quite a while since we have had 2% growth.

John Glen

Dr Beck-Friis, do you have any response to what Lord O’Neill has said, particularly about the market’s behaviour on gilts?

Dr Beck-Friis

I agree. If you look over the last year, we have seen a lot of volatility in global fixed income, and a pretty sharp repricing in global fixed income. UK yields are higher, but they have been higher or going higher in most other countries in the world, so the US, Japan, most of Europe and Australia. It has not been driven by UK-specific factors but instead by global factors. I am sure we can get into these, but the energy shock has been part of it. The fact that we are in the midst of a global capex boom is part of it. I do not think that global fiscal policy or debt sustainability concerns have been a key driver of why rates have increased over the last year or so. That said, if you take a snapshot of where yields are now in the UK, they are high, and a little bit higher than in the US. The reason they are high is that the front end of the curve is high. That means that the policy rate is high, and there is an expectation that the Bank of England will tighten monetary policy going forward. Four hikes are now priced in for the Bank of England over the next year, and this clearly relates to the inflation outlook. Inflation has been high for a long time, and there are inflation risks going forward. On fiscal policy and fiscal policy credibility, yes, that is lifting yields a little bit here in the UK, but I would not overplay that. Perhaps it is worth about 20 basis points or so. The way you can look at this is to look at the shape of the interest rate curve. When markets are getting worried about debt sustainability and fiscal credibility in a country, the curve tends to steepen. The long-dated bond yields tend to go up more than those for short-dated bonds. If you look at the shape of the UK curve, yes, it is a little steeper than in the US and Germany, but again, in the context of perhaps 20 basis points or so, I would not overplay it. The key reason why rates in the UK are high is that the Bank of England policy rate is high, and there is an expectation that it will raise the policy rate going forward.

John Glen

Did you want to say anything more, Lord O’Neill, on that first question?

Lord O’Neill

I agree with that.

John Glen

Professor Valero, would you address the same question, please?

Professor Valero

I can perhaps speak more in depth on growth, productivity and those aspects. The IMF concluded that, globally, we have seen more resilience than perhaps was anticipated, but we have also seen, as Jim said, that the UK has done relatively well. While our growth is not good relative to the past, where we had growth rates over or around 2%, so far in 2026 we are top of the G7. In terms of where the IMF and the OECD have put forecasts for this year, we are second in the G7. This is something to celebrate in some sense. There have been a lot of issues and uncertainties globally to deal with. Underlying that, to go a bit more into the productivity data, since the financial crisis many of us have been working on this productivity puzzle in the UK. It is something that is shared by other economies, but the UK’s was considered to be worse. This was an issue for us because we already had a productivity gap versus our main comparators, and our worse performance meant that the gap was getting bigger. Recently we have seen two revisions in the data, which suggest that actually our productivity is better than we thought. In per-worker terms, since 2024 performance has been improving when we use better-measured labour inputs, so administrative data from PAYE tax records. You will see that, between 2024 Q3 and 2026 Q2, GVA per worker has increased by 2.8% over that entire period. Annualised, it is 1.6%. This is actually quite close to our pre-crisis trend in per-worker terms, which was around 2%, and much higher than what we saw in the previous methodologies.

John Glen

Has there been any attempt to retrofit the methodology to previous periods?

Professor Valero

Yes. This is now taking a restated period.

John Glen

That is from the GFC to 2024 as a whole?

Professor Valero

Yes. All this is driven by how you measure workers. To Jim’s point, it does not necessarily seem to be a shedding of lower-paid workers in sectors. The Resolution Foundation has done some work on that. We have also looked at the sectoral makeup, as it has too. It is quite broad-based across sectors as well. ICT makes quite a positive contribution, but so do other sectors. That was GVA per worker, so one way of measuring productivity. The other, more recent, revision is to do with how we measure hours, so bringing our methodologies in line with international approaches. This is actually a big shock. That shows that our slowdown since the financial crisis is not as bad as previously thought. The previous thing I talked about was the recent uptick. Now I am talking about what we have seen in that entire period since the financial crisis. GVA per hour is a better measure because you can account for the fact that different workers work different numbers of hours. Before the financial crisis, we had around 2% annual average growth. Restated, it is now 1.3%. That is really important.

John Glen

Can I ask you about that in principle? It probably seems strange to people watching this that you are restating the last 16 or 18 years of productivity trajectory in the economy, as a consequence of a new statistical method. Is that what you are saying is happening?

Professor Valero

Yes.

John Glen

It was true anyway, except we did not measure it right?

Professor Valero

Yes, that is the thing. It is a measurement issue. Of course, this does not mean that our productivity issues are solved. It does not. Ultimately, we have seen stagnating living standards since the financial crisis. We still have an overall slowdown that needs to be dealt with. We have large-scale regional gaps within the country, and we still have that gap with our international peers, so of course we still need to focus on raising productivity. It is just this aspect. There are two sources of optimism. One, our slowdown has not been worse than our comparators. Two, we have had an uptick in per-worker terms more recently. You can then look at the things that underlie productivity growth. We have also seen that business investment, for example, is seeing some uptick over the recent period.

John Glen

I am mindful that more colleagues want to come in. Can we look at the context for the Budget—that is what we are here for—in terms of what things are going to drive growth and productivity? Lord O’Neill has made some statements over the last few months, and we will come to them in a moment. What should be the priorities for the Government, in terms of the decisions they can make two weeks today, to improve the growth and productivity trajectory, and to continue what you say is already happening?

Professor Valero

We have this recent uptick in business investment. We have seen business confidence recovering. This is fragile, given the continued global uncertainty, so I would not want to see that damaged. This is in line with what you have talked about recently, so being mindful of raising costs for business to maintain this increased investment and positive sentiment. I think the Barclays Business Prosperity Index talks about confidence rising and stronger appetite for investment.

John Glen

More tax on banks and energy companies would not be a good thing.

Professor Valero

In general, I would prefer to avoid taxes on business, but this is a difficult fiscal context and there are many different objectives. The other thing I would want to prioritise, and this is something the previous Chancellor did with her change to the fiscal rules, is public sector investment. This has historically been the margin to be adjusted when fiscal situations get difficult, but this is so crucial for growth.

John Glen

Lord O’Neill, you have made a significant intervention against the alignment of CGT rates to income tax. It seems to me that is probably being ruled out, or at least the realignment has, whether or not there is actually going to be an increase in CGT. It seems to me that Rachel Reeves did a delicate job of increasing CGT to an optimal level to increase revenue, but not to deter people from liquidising their assets. Do you think any further increase in CGT would be detrimental?

Lord O’Neill

To refer back to Anna’s thing briefly, even without the data revisions, I think I am right in saying—Anna, you know it better than virtually anybody—that, on the old data, there also has been a productivity improvement in the past few quarters.

Professor Valero

Yes, potentially marginal. It is not too much. I have the data here.

Lord O’Neill

My overall view, which I reiterated in just the past few days, is that, because of these cautiously encouraging trends, the last thing the Budget should be doing is anything that interrupts them. Given how business feels so beaten up, over however far you want to think, any tax increase needs to be thought through more carefully than before, especially things such as CGT. In another part of my life, I am heavily involved in venture capital investing, especially as it relates to regional things. This is highly risky stuff. This simplistic view that it should be taxed at the same level as income, in my view, has simply no understanding of those kinds of things. More importantly, and I am sure we will get into this quite a bit—quite a few of you guys have been involved in this stuff before—the whole reason why there is a fiscal buffer has got a bit lost in the way people look at it. It is supposed to be for when there are exceptional circumstances. I personally think that these are pretty exceptional, as one of you mentioned as part of your questioning, with oil prices in particular. Who knows where our wonderful leader in Washington is going next, but it is not inconceivable that, a week after the Budget, oil prices could be considerably lower. You want to use the buffer when you really need it, in my view.

John Glen

Can I draw you a bit more on two aspects? One, do you think that means no increase in CGT at all? When we talk about financial services, that is an industry you are intimately familiar with and have been a senior leader in for many years. If you think of the employer national insurance, the corporation tax, the surcharge, the levy and the fusion of those, I used to talk to bank CEOs and they moaned several years ago that it was too high. The mood music from people I speak to in the City is that they are expecting an increase in tax on banks. On those two specific elements, what is your view on what should happen in two weeks’ time?

Lord O’Neill

I would be more opposed to anything on CGT. If some numbers have to be found, I would think it might default to some kind of modest move on bank taxes. I would not be a fan of that either, for the reasons that you touched on. You have to make the numbers work on something, and everybody always rules out the infamous manifesto pledges. You have to do it on something.

John Glen

One other thing that you are a great proponent of and advocate for is looking at the regional economy. Mindful of time, is there anything you would like to say in terms of stimulus there?

Chair

We will come to this in more detail later.

Lord O’Neill

For me, this is the most important thing coming in this Budget. I think a lot of people do not quite get how this Prime Minister thinks it is a pretty important lever that the country has underutilised.

John Glen

If I may, I will return to Dr Beck-Friis on the question of what measures would be most impactful for productivity growth in the Budget in two weeks’ time. How would you respond?

Dr Beck-Friis

I can speak from the point of view of what the bond market would like to see. It is easy to say from a bond market point of view, because I understand the political constraints on tightening fiscal policy, but the bond market would welcome more fiscal tightening and, in particular, an effort to bring down the near-term deficit, not the long-term deficit or the headroom. To the extent that the Government surprise the market with more tightening than expected, I think the bond market would—

John Glen

What if they do not?

Dr Beck-Friis

If they surprise with running more expansionary fiscal policy and there is more fiscal slippage, the bond market is now on high alert and that would almost certainly lead to higher interest rates, depending on what type of fiscal slippage it would be.

Bobby Dean

To follow on from that point, I appreciate the point you made, Lord O’Neill, about how the headroom is there for buffer room and this is a time to use buffer room, but it also feels like we are living through times where there is always an excuse to eat into the buffer room. Every year there is a new event that means that perhaps now is the time to eat into the buffer room. It is one of the reasons, I guess, that the previous Chancellor was forced into lifting the overall headroom, because it was being buffeted by events. Perhaps this is also a question for Dr Beck-Friis, so please come in afterwards. Do you think the bond markets would tolerate it if they were to say, “Actually, we need to eat into the buffer again, because yet again there is a crisis in the world that we need to work around”?

Lord O’Neill

It is clearly a risk, for the reasons you say, but it could be carefully explained. The way things seem to work these days, what is also interesting so far about this Budget is that virtually nothing of what they are supposedly planning to do has been leaked, except the fact that they appear to have floated the idea of playing around with the headroom, partly to get the reaction of people in the gilt market, I assume. It does not look to have upset them yet. It is a risky thing because of exactly what you say. I personally think we have something a little rare in recent years, as there appears to be some growth taking place, and there are genuinely wild things going on globally that have not been there to this degree, other than maybe in the first year of the Russian invasion. The Budget numbers look more difficult primarily for these reasons.

Bobby Dean

Of course, we had tariffs and wars in between.

Lord O’Neill

It comes back to the big picture things. Chair, I am sure we will get into what are often called the sacred cows, or what we now like to call golden opportunities. Personally, I think the bond market should be, and probably is, more interested in how serious a leader in this country is going to be at some point about dealing with the things that seem to petrify everybody. If they do that, I do not think it makes the slightest bit of difference whether it is £5 billion wrong here or there.

Chair

It is a call for political courage.

Bobby Dean

That sets up my next question for Dr Beck-Friis.

Lord O’Neill

It is leadership.

Chair

Leadership is good.

Bobby Dean

We often obsess about this point figure, and I think you indicated in your previous answer that that is not the thing to focus on. It is certainly not the bond market’s focus. Let us assume that the buffer level comes down, for whatever reason. What else would you be looking out for to reassure you that debt sustainability was still going in the right direction?

Dr Beck-Friis

I think the bond market will be fairly sanguine if they reduce the headroom to £15 billion. If it is £10 billion, £15 billion or £20 billion, these numbers are very small in the context of the uncertainty. We spend a lot of time at PIMCO debating where the economy is today and where it will be in three months’ time. If you are forecasting where it will be in three years’ time, the uncertainty band is so high that we and the bond market put very little weight on a few billions three years out, particularly in an election year. Markets will discount. Of course, to the extent the Government reduce the headroom, that is a bad signal in terms of fiscal commitment, but it is not what the bond market will focus on. When I open up the OBR document, the first thing I will look at is what the gilt issuance will be this year and next year, and in particular what the deficit will be this year and next year, and potentially in two years’ time, because that dictates the amount of issuance. The closer it is to today, the more credible it is. For us—I said this last year, and we continue to say it—it will be increasingly important to see that the deficit continues to come down. It has come down. Now it is running at around 4%. A year ago or two years ago, it was 5.5%. There has been a reduction, but there is more to do. The bond market will be looking for that deficit to continue to come down, particularly to something close to a three handle. Preferably, the bond market would perceive a mid-to-low three handle next year as very encouraging.

Bobby Dean

Moving on to other things that drive growth, Professor Valero, I know you were involved in the formation of the industrial strategy in your time with the Treasury. Could you explain to me how you think the industrial strategy is going to drive growth? Could you address some of the headline criticisms of industrial strategies in general, about whether you should just leave things to market devices and the Government should not be involved in this space because of picking winners, et cetera?

Professor Valero

There has been quite a development in the way economists think about industrial strategy in recent years, internationally and in the UK. I do not think it is a substitute for getting the right horizontal conditions for growth and investment, so economy-wide policies, whether that is planning reform or pensions reform to get investment flowing. All those things are really important. The reason I think there is a role for more targeted vertical policies, which we might think of as industrial policy, is that Governments always have such policies, even when they do not have a proper strategy setting out how they make decisions around them. Also, given that we have limited resources and policy attention, it is worth focusing that into the areas that are most likely to drive growth. The reality is that different sectors and technologies face different barriers to growth. Some of them might be more emerging sectors where, say, R&D grants are really important and there are decisions made all the time about what should be priority areas to fund. Others are financial services and professional and business services, which are major sources of growth in the UK. It is perhaps more about talent and the regulatory environment, and less about subsidy. There is this important role if we want to get growth. We have a number of things we are really good at. A lot of the analysis we have done at the LSE, and the Government have also done it to inform their industrial policy, is to think, “Where do we have strengths, either now or potential strengths we can leverage? Where is global and domestic demand likely to grow?” There are a number of other considerations too. What is the regional distribution of the opportunities it would bring? Does it contribute to resilience? That resilience point is really important in this day and age, because we are beyond being able to be completely agnostic about supply chains and where things come from. We cannot produce everything here in the UK, but there are certain arguments for having capabilities in some areas, or having strong international partnerships to make sure that we have secure supply chains. The IS-8 are all areas where we have current or potential strengths. It is not all about propping up incumbents, which is the old-style industrial policy. This has been framed as a modern industrial strategy, which is about innovation—so disruption as well—business dynamism and supporting those nascent sectors that could be big growth areas of the future. In doing so, the broad strategy has a number of cross-cutting policies. They are horizontal in many cases, but they might matter in particular for these sectors. If you take planning reform, that is obviously very important for net zero infrastructure. It is very important for lab space in places such as Cambridge for life sciences. There are these eight sector plans, and in each of those there is a much deeper look at what the evidence and the sector suggest the issues are. Also, what are the frontier technologies? It is not simply blanket support across everything.

Bobby Dean

I have one more question on that point. It sounds like you are saying that maybe the previous laissez-faire approach was a bit naive. It has left us exposed to particular risks in relation to resilience and did not allow us to grow our competitive advantage in key industries. If that is about getting those companies to start scaling and thriving, how do you feel about mergers and acquisitions? It now feels like, quite often, UK businesses are very quickly no longer UK businesses. Do you think that more needs to be done? You could register the fact that a foreign company wants to buy one of our businesses as a good signal for the economy, because we are producing those businesses in the first place. When you look at the rate, is that a problem for the UK economy?

Professor Valero

Competitive markets are really important for innovation and growth. There has been a lot of work at the CMA in terms of thinking about, in innovative markets, how you make sure that competition policy keeps pace. In some areas, we often slightly lament some of the big companies that have simply been bought up and have not been our own big growth stories. Perhaps, given today’s world and the critical technologies or areas where we need sovereignty, there is a stronger case for thinking carefully about who ultimately controls certain technologies and assets. This is a big debate, obviously, in AI for us and many other economies as well.

Chris Coghlan

Dr Beck-Friis, if the UK entered another downturn, how much scope do you think the Government would have to borrow more without putting debt sustainability at risk?

Dr Beck-Friis

That is clearly the drawback of having high debts. We have seen this not only in the UK but in many other countries. You can see this in response to the ongoing middle east war. The fiscal response, not only in the UK but elsewhere, has been very limited compared with the response that we saw in 2022, or certainly during the pandemic. I do not think there is much fiscal room for the Government to run more expansionary fiscal policies. The good news is that, even though there is not a lot of fiscal space, there is a lot of monetary policy space at the moment. In the next downturn, I would expect the Bank of England to have to do the heavy lifting in terms of running counter-cyclical policy.

Chris Coghlan

If the Chancellor was to take action now to try to have more fiscal space for a future downturn, is that potentially counterproductive because you could damage growth in the process?

Dr Beck-Friis

To the extent that the Government reduce the deficit when the sun is shining, that is obviously better to have. Going into a rainy day, you want to start with a lower deficit. To highlight the game between fiscal and monetary policy, to the extent that the Government tighten fiscal policy now, there is a lot of room for monetary policy to offset the negative drag that tight fiscal policy would imply.

Chris Coghlan

Lord O’Neill, you have argued that the Government should be bolder about investment-backed borrowing, perhaps breaking the fiscal rules. Could the Government credibly borrow more to invest in the current market conditions?

Lord O’Neill

I do not think that they should be breaking fiscal rules, as I think I heard you slip in at the end. No, I do not think they should. However, the second rule is designed to have more ambition on public investment spending, which I definitely believe in, done with one very important addition that I am trying to use any opportunity I have to push for. We need an OBR for infrastructure, so that we can get out of some of the mad game that goes on in our wonderful democracy, where we do not ever seem to be able to deal with anything that is long and might cost a few shekels. What if we had a very publicly known and credible independent body that opined on project X’s multiplier effects? Not just the gilt market, but all markets are crying out for the UK to do something like that, so people understand that we are actually investable. You could definitely borrow plenty more in those circumstances, as opposed to, “Trust me. I know best”.

Chris Coghlan

You say infrastructure. Would you include R&D as well?

Lord O’Neill

Yes.

Chris Coghlan

Dr Beck-Friis, when you came, I think a year ago, I asked you a similar question. If I remember correctly, you thought that bond markets would not find it that credible if the Government were saying, “We are going to borrow to invest. Therefore give us a lower rate”. Is that still your view?

Dr Beck-Friis

To the extent that the Government choose to borrow more to invest, that would almost certainly lead to higher yields. That could also crowd out investment in other areas, because the UK in particular is really pushing at the limits of credibility. To reiterate, the bond market first and foremost cares about the headline deficit. Of course, the composition of the deficit may matter. To the extent the Government borrow to invest, that may improve GDP growth, and that may be a positive for the fiscal trajectory as a result, but there is a lot of uncertainty around the multiplier and when that would show up in the GDP numbers. Until that has shown up, I think the bond market will discount it quite heavily.

Lord O’Neill

I emphasise that it requires some new credible independent body. If it is just “trust me”, our history tends to suggest, “No, I am not going to”.

Chris Coghlan

To finish the point, could one way be to issue bonds that are contractually limited in terms of the use of the proceeds, such as restricting the bonds to either infrastructure or R&D?

Lord O’Neill

We need something completely different from what has been the modern norm. That is vaguely possible, but I would not favour that route. There is another thing. I do not know whether it will come up, Chair. I have also been persuaded that we should consider playing around with the tax incentives to do with pension pots. I have become a big fan of the idea of removing the tax-free lump sum unless it is invested in UK assets. As somebody just amusingly pointed out to me at an event I was at earlier, right now Nvidia has a bigger share of global market cap than the whole of the UK equity market, and what happens to its share price matters more to our pension investments than getting a tax benefit. Why do we not change the risk-reward so that you avoid that kind of feeling, if there is going to be a better framework for infrastructure investment?

Professor Valero

I want to agree with some of that. We have the public finance institutions that have been boosted significantly. If they were to have even greater capacity, I do not think that would impact on the fiscal rules. Of course, it would still be borrowing, so that makes it even more important that there is some sort of evidence-based adjudication that anything that is being done will generate a return, is worth the extra borrowing and is truly additional as well. This is the remit of these types of programmes in the British Business Bank and the National Wealth Fund, et cetera.

Chris Coghlan

The former Chancellor had higher levels of public investment in the first Budget. Is that driving part of the productivity increase, or more broadly?

Professor Valero

That is really important. I think it was over £120 billion of extra publicly financed capital expenditure versus the previous Government’s plans. This is really important. Such projects take time to have an impact. The OBR scored them, and there is some lag. We do not know for sure what is driving the pick-up in productivity so far, but I would hope that it is a range of reforms that have been put in place since 2024, and some of the things that Jeremy Hunt did as well. He started the pensions reform and full expensing of capital investment. I would hope that some of those things are starting to feed in. Indeed, when you talk to people in the high-growth firm community, there is an appreciation that a lot of the different elements are now in place. We are waiting for the finance to start flowing, and maybe additional incentives are needed.

Ms Minns

I represent a northern constituency.

Lord O’Neill

Good for you.

Ms Minns

It is genuinely north. I represent Carlisle, Lord O’Neill. You have made some comments recently about the growth in every postcode strategy, saying that it is not the tactic you would have taken. What is a better strategy than growth in every postcode?

Lord O’Neill

It depends for what purpose you are saying it. The best way of getting growth in every postcode is getting 10-year bond yields down 200 basis points, because that would affect everybody who has to borrow for anything. It has been used in the context of giving devolved powers. From my nearly 15 years’ experience in a lot of this, that is a very dangerous path to go down. It opens the door to every part of England at least, and maybe others, saying, “Give me some money”. Whether they have the capacity, ability and desire to take the responsibility that goes with it is among the many questions. The other very important additional point is that, if that is going to be at the centre of your approach to trying to achieve greater national growth, you really have to prioritise the places that are going to matter. A slightly uncomfortable thing for me in this context, and maybe for somebody from Carlisle, is that, despite the fact that London’s own growth performance has been very weak by its own standards in the past 15 years, and so the gap has narrowed, it is still the case today that London is the same size as the next eight most important places put together. It is quite an interesting challenge for this PM. They should try to do something about at least helping London stop slowing. Then, in the rest, you have to pick the places that really matter.

Chair

I think you are playing to the gallery. I should say that there are four London Members on the Committee.

Lord O’Neill

I had no awareness of that.

Ms Minns

You lead me very neatly on to my follow-up question, which is to you and Professor Valero. How should Government identify those places?

Lord O’Neill

They have to be really careful about it. I am a fan of encouraging or allowing some competition, but you certainly do not want to hold back the places that already appear to be showing some progress with the limited devolution that they have had, not least because that will encourage other areas, maybe including your part of the world, to entertain the structures and additional responsibilities that I believe should go with it, rather than just saying, “Here is some money. You try it and see what happens”.

Ms Minns

Do you think it is possible to put some criteria around that?

Lord O’Neill

Yes, I do. I wrote a foreword for a piece that IPPR North and IPPR put out about that. It had some very specific criteria for how you would layer different strategic authorities.

Ms Minns

Professor Valero, it is the same question to you. What would be your criteria for identifying those places with the greatest potential?

Professor Valero

I agree with that. For me, when I hear “growth in every postcode”, it can mean different things when you are talking about different policies, or even to different audiences. Ultimately, everyone wants growth to be felt in every postcode, but I think most people would agree that you are not going to have an innovative cluster in every postcode. If you look at the PM’s speech last week, he emphasised that you will have perhaps one global cluster in every region. That is not spreading the jam. To have more regionally balanced growth, we are going to need to identify those clusters. Your question is how you identify them. I have been in lots of discussions recently with the research and policy community, thinking about data. This is really important. For measuring innovation and growth potential, you need a range of datasets, particularly on place. No one dataset gives you all the answers. Then, you complement nationally comparable data with locally generated data, which will give much richer insights, but will not necessarily be comparable. Based on that data and the evidence, where are regional strengths? Where is it a true strength, and where is there some evidence that policy could address the barriers and see growth? It is really important to think about the connectivity. To get growth in every postcode, it is about effective and functional labour markets so that people can access the jobs. Unfortunately, that just does not happen in many parts of the UK. In London, we are lucky because you can travel quite far to get to your job and it will be a good job, because London is, even in absolute terms, the eighth innovation cluster in the world, based on academic publications, patents and venture capital investments. This is something that is crucial for our growth. I agree that, for us to grow nationally, we need to continue bolstering London, while understanding that there are very real gaps that policy can address. For too long, we have been too centralised. There is strong evidence that decentralisation will help that. The industrial strategy has begun quite a detailed process of regional strength identification. It has identified where these different growth sectors cluster. If we want to prioritise even more, we are going to need more of that analysis while—it sounds difficult, but I think it is possible—combining the different sources of evidence together.

Ms Minns

Can I ask you both, based on what you said about focusing on the areas that have the greatest potential for growth, what you would do about the Heathrow decision?

Lord O’Neill

I would link it to what I said before. Heathrow is a perfect example, as is HS2, of why we need an OBR for infrastructure. I am yet to see an independent assessment of whether Heathrow has major positive multipliers.

Professor Valero

My understanding of the case made at the time was that there is not just a benefit for London, but there would be spillovers to the rest of the country. London is a global city that is facing increasing international competition. There is that economic case, but for sustainability reasons I would want to know that any extra emissions are compensated through further action somewhere else.

Ms Minns

I have one final question to Dr Beck-Friis. On this point about place, and going back to what you were saying about the effect on gilts, is there any scope to borrow more for regional investment without pushing up gilt yields?

Dr Beck-Friis

The bond market does not focus too much on the regions versus the federal level, so there is no difference between local authorities or the federal. The bond market would look at the general Government balance sheet and make its assessment, but whether it is from local or federal does not make much of a difference.

Chair

We have had a bit of a discussion about devolution. Obviously, as you say, Lord O’Neill, the Prime Minister is very committed to this. Perhaps I could come first to you, Dr Beck-Friis. There is a financial discipline in Government. There are mechanisms for holding a Government to account for their spending. With the mayoral model in this system, there is not such a mechanism in place. It is a lot weaker. How would the markets react to money going out to local areas if there are no accountability measures built in so that every tax pound is being followed and scored?

Dr Beck-Friis

This is not something we debate at PIMCO, and I do not think bond markets would focus on this at all, frankly. There are much more important drivers of the bond market.

Chair

Okay, that is very helpful to know. One thing being discussed is mayors perhaps getting a share of income tax. Lord O’Neill, do you think that is something they should have?

Lord O’Neill

In principle, yes. Because of my previous life, spending half of it sitting on a plane going somewhere, including living in the US twice, I do not think we should regard it as such an “oh my God” thing that different parts of the country can explore different forms.

Chair

Do you think they should be allowed to vary it, like in the US?

Lord O’Neill

I am not sure I would want to see it announced that it is happening in this Budget.

Chair

That is probably a bit too early.

Lord O’Neill

In principle, yes.

Chair

What about the areas without mayors, such as Cornwall?

Lord O’Neill

That goes to your previous question, because I believe we need to have strengthened accountability. I would be pretty cautious about that. It also goes back to this question. Part of the reason why the competitive thing appeals to me is to encourage places that are not getting what they could because they refuse to accept the greater need for accountability and responsibility. I have spent many wasted hours over the past nearly 15 years on that issue.

Chair

Under the previous Government, with the towns fund, there was funding to build competency and capacity in those areas. Often they were very small projects, so there were a lot of hoops to go through. We can discuss bidding for money and so on. Do you think that is going to be necessary for some of the new mayoralties?

Lord O’Neill

The capacity thing is extremely important, including for some existing mayoral authorities.

Chair

There has been some evidence, and Manchester is a good example of this, where national civil servants, bodies and people have been attracted to go and work there rather than in Whitehall. That is still quite underdeveloped. There are parts of the country where people do not choose to go to further their career.

Lord O’Neill

This is an essential, urgent challenge for No. 10 North to build that capacity there for itself, but also to help build it in other places. It is crucial.

Chair

It is difficult to put a timescale on this, but realistically, the last time there was a Labour Government, before 2010, Manchester was often the crucible of experimentation, because there was good, strong leadership there even before a mayoralty was introduced. There were other areas of the country that did not have that capacity. If that was the case then and is still the case today, how long will it take?

Lord O’Neill

Because of my involvement in it, I do not want to name places for obvious reasons.

Chair

It is the general point that there is still a lack of capacity.

Lord O’Neill

I have a general answer for you. There are places that are showing some signs of success, and it is not just Greater Manchester. I was part of a small group recently with the current Chancellor, and it was pointed out to him that the borough with the fastest growing productivity in England is actually Rotherham, his seat. It is because of the AMRC, actually, linking directly into that. It is a pure fluke of geography. It is because of the University of Sheffield, really. I personally think that there are some signs that South Yorkshire is starting to show some momentum. I was at a big thing in the west midlands last week, and I detected that more than I would have done before. On the things that their team are looking at, they should consider taking some risk on the places that are already showing signs of momentum, on the data we can get, and of better growth and that, on their own analysis, are capable of taking some of the responsibilities that could be on offer.

Chair

I will bring in both you and Professor Valero on tax. If a proportion of tax is devolved and revenues drop, do you think there should be some protection for those areas? It can be a lumpy source of funding.

Professor Valero

There are lots of debates. To step back for one second, there is quite a lot of agreement that some fiscal devolution will be a good thing for growth. Where there is real debate is on the implementation, because of capacity, accountability—what we have just discussed—and then exactly what the design looks like. One aspect of design is which taxes and what share. The other is this issue of equalisation. There are lots of proposals out there on what that equalisation would look like to protect places that see a fall. That is really important.

Chair

Some areas might do very well. We have a system for business rates, but there has been a lot of debate about that. If you were advising the Chancellor now, what advice would you give? How would you crystallise that?

Professor Valero

First, I would sequence this, with the places that have the underlying evidence-based capacity. Secondly, I suppose it is about whichever tax is going to be shared, then thinking about modelling what different scenarios look like, which places might be more exposed and therefore what the optimal design is. You would ultimately need to have some scenario analysis and then think about how to go about it, learning lessons from other taxes or other countries that have similar mechanisms.

Chair

Then there is the pace at which this is done. We are hearing reports in Whitehall that some Departments are being asked to give large amounts of money to local areas as soon as they can. My background means that I am naturally cautious about pouring money out from Whitehall where, for all its faults, there is an accountability process. How quickly do you think we can get the fiscal devolution that is being talked about?

Lord O’Neill

For welfare reform, this is an extremely crucial question. As you probably know, Chair, and maybe all of you do, Greater Manchester has been playing around with something it calls a prevention demonstrator. I do not think any other area has the same thing yet. That is certainly influencing the mindset.

Chair

For those who are not aware of it, do you want to give a sentence to explain?

Lord O’Neill

It is about trying to connect with all the different beneficiaries of welfare and people in hardship. On one level, it is like a modern version of David Cameron’s—I have forgotten.

Dame Siobhain McDonagh

Big society.

Lord O’Neill

Yes, in some way, or his troubled families group.

Chair

That was Tony Blair.

Lord O’Neill

It is a more ambitious, bigger thing than that. To ultimately solve many of the complexities that relate to our welfare challenge, it is, to me, intellectually the right thing to do.

Chair

Intellectually, but at what pace?

Lord O’Neill

This is partly—well, not partly. This is greatly why the capacity thing is so important. You cannot conceive of doing that in places where they have not even thought about it for themselves. The whole notion of devolution, at least for me, is to give places some responsibility for what they think they can do, rather than saying, “You must all do this”.

Chair

How do you resolve the tension?

Lord O’Neill

You have to be tough. You have to be a leader.

Chair

You are saying that Whitehall still has a tough role to play. It needs to play a tough role to hold them to account.

Lord O’Neill

Whitehall has a tough role to play in two ways. One is that, from my limited experience, a lot of Departments do not like to give up anything. Especially as it relates to where welfare is going to go, I suspect that quite a few of them are going to have to give up quite a bit. That is possibly the bigger challenge than the other one that you are asking about. There then has to be pretty serious analysis of whether there is the competence and capacity to handle it.

Chair

And, indeed, measuring the outcomes.

Lord O’Neill

Yes.

Chair

There is no process in place for that.

Lord O’Neill

Again, in my recurring mention of an OBR for infrastructure, in my view, when it comes to boosting trend rates of GDP, it does not just have to be physical things. As it relates to early years education, I would suggest that there is a very strong case for thinking of it in that kind of framework, and for other things too.

Professor Valero

In terms of pace, there are some processes already in place as part of the existing spending devolution agenda, where some places were accelerated as part of the trailblazers, as they were called. When adding in new areas of spending, the pace depends on the extent to which we feel that good decisions can be made, which depends on local capacity and local growth plans and strategies being in place. I was on the South Yorkshire mayoral advisory council before the election, and in the early stages of its growth plan. It had clear views on what some of the strengths and assets were in the region, and what some of the barriers are as well. Taking, say, innovation, the PM’s speech last week talked about more devolution of some of the more applied parts of innovation. For that, the risk that those of us in the innovation community would talk about is whether you are going to erode the extent to which funding goes to excellence and, if every place does not have a full picture of national excellence where it is, how the region compares to that. It is really good to have seen in that speech that UKRI would be closely involved. These partnerships between national institutions and local leaders are so important. Again, there are things we can build on there, so the National Wealth Fund with regional partnerships, the OfI with some of the regional capacity building pilots that it has been setting out, and the Green Book review and further promises since then to build capacity through secondments and other things. All those things are really important to have that analytical capability to put projects together, assess them and then work with the national institutions to make sure that there is some sense-checking and comparability.

Chair

Of course, politicians always want everything yesterday, and this takes a bit of time.

Chris Coghlan

Lord O’Neill, is replacing council tax and stamp duty with a proportional property tax one of the measures you are interested in and, if so, why?

Lord O’Neill

Like most economists, I think we should move as much as we can to taxing the land as opposed to what is on it. It is one of the rare things where—

Chair

All economists agree.

Lord O’Neill

Yes. That possibly could mean it is wrong, but I believe in that. Assuming that is not going to happen next week or in the near future, it is blatantly obvious to me that we should update the way we approach council tax bands.

Dame Harriett Baldwin

We have invited you in two weeks before the Budget because we want to get your insights into the challenges the Chancellor faces in the Budget. I wanted to start, Professor Valero, by asking you for the top three mistakes that the previous Chancellor made in her two Budgets.

Professor Valero

That is a really difficult question. I am not that comfortable about answering it. I suppose we could go by some of the things that have attracted public criticism or been reversed. I think everyone would agree that welfare needs to be reformed, but it is quite obvious that that is very hard to do quickly. It needs to be quite detailed reform of the system, and it is harder to make cuts. She got so much amazing stuff in place on growth. A lot of my work is focused on how we get growth, and that takes a long time.

Dame Harriett Baldwin

That is not what I asked. You have mentioned one, which was failure to reform welfare. Were there any other mistakes?

Professor Valero

Getting the fiscal position on to a sustainable footing required some difficult decisions. We all know that it is always difficult to raise a tax. There are always losers and trade-offs. Of course, things such as employer NICs raise costs for business, which we have been talking about. That is not a good thing for growth, but doing lots of other things that are good for growth while also getting the fiscal situation on to a more sustainable path is good for growth.

Dame Harriett Baldwin

Did any of the tax hikes take things over the peak of the Laffer curve, as it were?

Professor Valero

I do not have a view on that. I would want to have done my own analysis to have a view on that, to be honest.

Dame Harriett Baldwin

We have this wonderful professor and expert, and I just wanted to hear more than one mistake—I heard failure to reform welfare. I am going to ask Lord O’Neill next.

Lord O’Neill

I was on a call with the one and only Art Laffer two days ago, and I know what his answer would have been. It would have been no. This is relevant for how the current leadership appears to have started behaving. The bigger mistakes were made in the run-up to the Budget, including when they were taking power, where they frequently created an atmosphere of, “We are going to be big friends of business”. Then, within a fortnight of being elected, they said, “Actually, no we’re not”.

Dame Harriett Baldwin

“Here is £25 billion in taxes”, yes.

Lord O’Neill

There was a huge gap between that statement and when the Budget actually took place, and they still got negative surprises. That was a major mistake that set the tone for virtually everything that followed.

Dame Harriett Baldwin

Dr Beck-Friis, did you want to answer that question, from the point of view of a bond market practitioner?

Dr Beck-Friis

From a bond market point of view, if you go back to the first Budget in the autumn of 2024, the bond market reacted pretty sharply in response to the Budget and sold off sharply, more so than in other regions. There were two reasons it did so. First was the inflationary nature of the tax hikes, particularly the national insurance hike and the higher minimum wage. To some extent, that was part of why inflation remained high, and that complicated the Bank of England reaction function, so you saw that repricing of the Bank of England expectation. The second point was that the fiscal tightening was almost exclusively delayed into future years, as opposed to in the very near term. The fiscal deficit did not really improve much in the first year. If you fast forward to the second Budget—was it in December or November last year?—the market reaction was much more benign and gilt yields fell in response to the Budget, not by much but a little bit. There were no inflationary tax hikes. There were, in fact, disinflationary measures and there was an improvement in the fiscal headroom. From a bond market point of view, that was more welcome.

Bobby Dean

We have talked a bit about how we can achieve growth, but growth also takes some pretty big hits at times, whether when we had the health pandemic or maybe during climate-related shocks to the economy. I am interested in this question about sustainable growth. We talked about Heathrow earlier and, Professor Valero, you mentioned the trade-offs with emissions. Sometimes that is posed as a political question weighed up against an economic one, but is that actually the case? Should we not be weighing up the short and medium-term economic growth benefits versus the potential long-term effects if we have to invest more in mitigation because of climate change? Is that an analysis that is already happening in Government? When you look at decisions such as Heathrow, Jackdaw or all these sorts of big environmental projects, is there an analysis about what the short and medium-term growth is versus the potential mitigating costs that might come as a result of that type of project?

Professor Valero

That is a great question. Talking about resilience, things that involve some cost, which is often an investment today, build resilience to a future shock and therefore that would be great because you will have less of a negative fiscal impact when that shock comes. This kind of analysis happens. There are often intertemporal trade-offs. You can take that to a really micro level to a firm making a decision on investment: should it invest in something like energy efficiency? That might look like a cost this year, but the next time there is a shock they are going to have much lower energy bills. Similarly for the country, when we have such big conflicting priorities, such as squeezed public services and the need to invest more in terms of CDEL, trading off that long term and the short term is difficult. What makes it even more difficult is that we are in this era of poly-crises, where there are many different areas that need to be resilient now. We saw the pandemic, climate crises—the need to adapt to climate as well as invest in mitigation—potential cyber-attacks, war, supply chains and everything else. That makes it extra complicated. On the sustainable growth aspect—and this is something that a lot of my work focuses on with colleagues at the LSE—it is not simply a cost in terms of a future benefit. Clean energy technologies and other clean technologies are identified in the industrial strategy as being growth areas, because many countries are investing in these technologies. We have seen the costs massively coming down. They are clean, modern, smart technologies. There are growth opportunities in those things if we purposefully try to capture them. That is the purpose of an industrial strategy. Rather than just thinking about deploying these technologies, let us build those supply chains so that our own firms can benefit from the growth that it brings.

Bobby Dean

Dr Beck-Friis, I am interested in whether the bond market thinks about this risk register of potential future shocks. If Governments are insulating themselves with greater investments—I don’t know—in the health system to be more resistant to a health shock in the future, is that the sort of thing that bond markets pay attention to, or is that too detailed at the moment? Is that below the surface and too uncertain for you to have an interest in?

Dr Beck-Friis

Give me an example.

Bobby Dean

For instance, let us say that we had more bed capacity in the NHS ahead of the health pandemic. That is something that maybe feels like just a social decision, but not having those beds maybe ended up costing the economy more because we were not prepared. There is climate too. We have had shocks this summer in terms of heat. We might have more flooding over the winter. You asked me for examples, so I am giving examples. It could be investments in flood defences, for example.

Dr Beck-Friis

No, that would be too detailed for the bond market to focus on.

Bobby Dean

Lord O’Neill, you mentioned having this OBR for infrastructure or broader investment. Could this functionality not already sit within the OBR itself, or do you think it needs to be a separate body?

Lord O’Neill

I have talked to people at the OBR. A lot of it is microeconomic analysis, where the OBR is set up for macro. The crucial thing is that it would allow the OBR to scorecard some of this stuff, where, when you put it to the OBR now, it is like “whew”.

Bobby Dean

That is the issue.

Professor Valero

It is worth noting that the National Infrastructure Commission, when it was first set up, was going to be put on a statutory footing and be more independent. It was then decided not to do that.

Lord O’Neill

Yes, exactly. That was a huge mistake.

Chris Coghlan

Lord O’Neill, in our recent inquiry into the OBR, this Committee recommended the addition of a second forecast horizon at 10 years on top of the existing one at five years. Could that achieve a similar effect to what you said would be beneficial?

Lord O’Neill

I did not know that. I remember discussing it with some very eminent people, including those who originated some of the medium-term financial strategy type stuff. The OBR should be encouraged to focus on the trend rate of growth. One of my own weird feelings in my brief time as a Minister in the Lords and the Treasury is that you were talking about all these changes, and the single biggest thing that always influenced everything was a change in the OBR’s latest forecast of next year. In my judgment from my previous life, as good as the OBR is, it does not have any edge over anybody else. From my experience, long-term GDP forecasting is easier than short-term GDP forecasting, because it is about things that move the trend. I did not know that. I am very sympathetic to that view.

Chris Coghlan

Professor Valero, one of my favourite subjects is public R&D. If I understand correctly, right now we are about middle of the G7 on this. First, how important do you think this is to long-term growth? Secondly, I think that, for 27 of the last 30 years, we have had the lowest level of public R&D in the G7. If we are really serious about long-term growth, surely we should be aiming to be at the top of the G7, especially as the numbers are not actually that large compared with other items of public expenditure.

Professor Valero

It was a couple of years ago now, but another area of data restatement was on business investment and R&D, where we found that we were not actually quite as low. We were relatively better than we thought as a share of GDP. R&D is massively important for growth. There is really compelling evidence. DSIT—now BIST—has some reports that show the broader returns on £1 of public money in R&D being, I think, £7 or £8. It is not just important in the abstract, though. It is important for an economy like ours, because—this is a proper source of optimism—we are a very innovative economy. We are also very innovative in things that matter in today’s world. That means there are growth opportunities, resilience opportunities and everything else. However, the issue is that there is rising international competition in many areas. Many other countries are spending a lot of money on R&D. We cannot necessarily compete in terms of that scale, but we can at least protect and build on what we have and make sure that we are, particularly on the applied side, channelling towards growth opportunities. On the basic science, you are not always going to know what those growth opportunities are, so the current UKRI buckets approach is a positive one. Our strengths stem from our strengths in the basic sciences and what we can apply out of that.

Chris Coghlan

Do you think we should be borrowing for R&D?

Professor Valero

It goes back to what we were talking about. We have the fiscal rules. It is important to stick with those fiscal rules.

Chris Coghlan

R&D is capital, though, is it not?

Professor Valero

Yes, it is, but we have the investment rule, which has already enabled more public sector investment, including R&D, in this SR period. Things such as the British Business Bank and the activities it does are allowing innovative firms to grow. That is a really promising mechanism for us.

Lord O’Neill

As part of this supply-side boosting thing, I would love to see more ambition, actually just from the mentality of the boards of the PuFins. A lot of them came into existence out of crises, and they often seem like yet another civil service Department, but they should be at the forefront, especially as it relates to the benefits of R&D, and we should have more ambition for them.

Dame Harriett Baldwin

I have two quick, geeky bond market questions related to the Budget. What is the market pricing in, in terms of headroom?

Chair

You covered some of this earlier.

Dr Beck-Friis

There is no market for the specific headroom. If you look across the sell-side banks and what they expect, we expect that the headroom would be somewhere between £10 billion and £20 billion.

Dame Harriett Baldwin

The second one is around the big transition that happened recently with the Bank, which was changing its approach to quantitative tightening and made a huge shift that moved the bond market and presumably had an impact in terms of the Budget numbers. Have you done an assessment of what impact that has on the Budget?

Dr Beck-Friis

The answer is no. It will have an impact on the flow and an impact on the stock. When the Bank of England is doing QT, it is reducing the size of the balance sheet, so you stop paying interest on reserves and are also getting less interest coupon. There is a trade-off between the stock and the flow, but nothing that we focus on.

Dame Harriett Baldwin

You cannot estimate what the Office for Budget Responsibility would score that as?

Dr Beck-Friis

I have not done that myself.

Dame Harriett Baldwin

If any bond market boffins out there want to send the information to the Treasury Committee, we would be very interested in hearing it.

Bobby Dean

Dr Beck-Friis, there has been a lot of chatter this time about the lack of chatter around the Budget and how the bond markets might be responding to that. The fact it has been tight-lipped means there will be less fluctuation. Do you think that this is a good thing, or has it just moved the moment to Budget day itself, when there might be more reaction, or stronger reactions possibly, if there is anything that surprises the bond markets?

Dr Beck-Friis

It depends on what is announced, clearly. It has been good in the sense that there has been a little less volatility this autumn. We need to put this in context. This year has been remarkably volatile, not because of the Budget but in global fixed income. Volatility has picked up everywhere, but it has, in particular, picked up in the UK since the start of the year. Volatility in the UK gilt market is now realised and has been much higher than elsewhere. We spoke about the level of yield and fiscal credibility. I think that this volatility partly reflects the notion around fiscal credibility in the UK, because, whenever you have an adverse shock—suppose energy prices go higher—the markets start doubting that the Government will do the right thing to balance the books. The reason I say that is that, while it has picked up everywhere, the three countries where it stands out have been the UK, France and Italy, and all these countries have some concerns around fiscal credibility. The nature of the shock has not been the UK Budget or fiscal policy, but more around the middle east and energy prices.

Chair

Dr Beck-Friis and Lord O’Neill, we talk about growth. We have to get investors investing. You have experience with this. What would persuade investors that the Chancellor’s commitments will be delivered? You have touched on it a bit, Dr Beck-Friis.

Dr Beck-Friis

Do you mean investors in the bond markets?

Chair

For you, in the bond market, yes.

Dr Beck-Friis

There are always going to be investors. The question is what price they are willing to invest at. This is easy to say from a bond market point of view, but lowering the interest rate, to some extent, attracts more international investors to lower the yield. First and foremost, tightening fiscal policy and reducing the near-term deficit is number one. Number two is to avoid the inflationary tax hikes that we saw two years ago. Number three, going forward, is less of a focus on this concept of headroom and more of a focus on gilt issuance and the near-term deficit.

Chair

That was very clear. Lord O’Neill, what is your perspective?

Lord O’Neill

There is a mood around, including from international people, that we never get anything right here. The market experience side of me thinks, “That means that, if we do, some of them might change their minds”. I am thinking about it from an equity market and infrastructure market perspective, as well as a gilt market perspective.

Chair

When you say we do not get anything right, are you talking about major Government projects such as HS2?

Lord O’Neill

It has been touched on in different ways. Of all the shocks that have hit the world, we have somehow managed to make a bigger mess of dealing with them than many other places, and we have arguably had a couple of self-induced ones as well. People are conditioned to, “Oh yes, the UK is that place that always gets everything wrong”. That is part of it. I touched on it earlier, but I think about this another way. Right now, America’s biggest stock market-quoted company is singly more valuable than the whole of our equity market put together. That does not seem to me to be, over the big picture, likely to remain the case, unless we keep getting everything wrong. It also links to how I described the sacred cows as golden opportunities, because the things that need to be dealt with are increasingly obvious. Behind the scenes, very slowly, it seems to me that the political bodies think, “Yes, sooner or later we are going to have to deal with them”. That is why I admire the announcement that has been made by this Prime Minister about the triple lock. I am a bit surprised that bond market people I talk to do not talk about that more, but it is conceivable that it could save anywhere from 2% to 5% of GDP by 2050. Going back to one of the questions about the OBR, its most valuable thing is its annual long-term debt sustainability.

Dame Harriett Baldwin

I thought it was to be ploughed back into the national care service, though.

Lord O’Neill

That was the way it was sold in the politics of it, but I think that, down the path of actually doing these things, they are two entirely different things.

Catherine West

Council tax will go up to cover that.

Chair

We are not having a conversation. Can I ask each of you in turn what is the single most important announcement that the Chancellor could make? Maybe I will give you two or three, because I recognise that it is hard to pin down to one, especially as you are economists.

Lord O’Neill

Has the time not finished yet?

Chair

Professor Valero, perhaps I could start with you.

Professor Valero

Do you mean in the Budget?

Chair

Maybe it is what he does not say.

Professor Valero

No, because there is obviously an SR coming next year. On growth, both are crucial here. I really hope to see capital investment preserved and increased over time.

Chair

By that, do you mean public capital investment and enabling private capital investment?

Professor Valero

We want that to crowd in private sector investment. We know that, for too long, public sector investment was too low in the UK, and volatile also. It was always adjusted, because it is quite easy to adjust in the sense that it is longer term compared with crucial day-to-day public services. I would like to see that. On tax, perhaps these are smaller things, but they can really matter. Things that, within the system, can incentivise more investment in the types of things that we want would send a very positive signal in terms of the direction of travel. One very minor thing is the incentives around investing in skills. Skills are quite a barrier to growth in the UK. We have seen employers investing much less over time. There is more we could do, particularly now, thinking about AI and the fact that businesses might be under pressure to replace workers and use these new technologies. Do we want to try to shape that by incentivising more investment in people?

Chair

Lord O’Neill, you cannot be stuck for words or an opinion on this.

Lord O’Neill

My view on what the most important things are will be different from what I think about them after the Budget. The devolution part of it, for me, is the most interesting thing, because it is the central priority, I think, of this Government. You would, therefore, expect their first Budget to have some pretty important things about that. That, broadly, to me, is the most important part. There are many sub-bits of it, one of which is that, personally, I would like to see almost complete devolution of adult skills to the most advanced mayoral authorities. Part of the problem, as I am sure many of you know, in these areas that have been there, is that they were supposed to have had a lot of skills devolved quite some time ago, but it has effectively been, “Yes, you have, but we are going to be monitoring what you are doing every five minutes”. That is not devolution. I am assuming that there are going to be no major damaging things on taxes.

Dr Beck-Friis

Commit to fiscal discipline. Make sure that there is no fiscal slippage in future years. That will have the benefit of, hopefully, reducing interest rates and interest costs for the Government going forward and freeing up some space to run more significant counter-cyclical fiscal policy in future downturns.

Chair

Can I thank our witnesses very much indeed? That is Dr Peder Beck-Friis from PIMCO, Lord O’Neill, who is many things, and Professor Anna Valero from the LSE. The transcript of this session will be available on the website uncorrected in the next couple of days, with thanks to our colleagues at Hansard. Thanks to our colleagues at Bow Tie for the broadcasting and thank you again to our witnesses.