New UK PM Andy Burnham's VAT Cut Faces Financial Market Scrutiny

Andy Burnham wasted little time making his mark.

Within hours of taking office, Britain's new prime minister Andy Burnham surprised Westminster with his choice of finance minister, opting for John Healey instead of the widely expected Shabana Mahmood. He also unveiled his first major policy: scrapping VAT, a consumption tax, on household electricity bills, saving the average household around £45 (roughly $60) a year.

The move is designed to put more money back into consumers' pockets. But while the tax cut may win over voters, there's another audience Burnham needs to convince: the financial markets.

Because while a £45 saving on electricity bills grabs headlines, the bigger question is whether his government can deliver those promises without undermining Britain's fiscal credibility.

Dare I offer a word to the wise though and point out that economic and fiscal stability is way more important to British households than an eye-catching VAT cut.

In fact, British households will be much bigger winners if the fiscal problems are addressed properly over the medium term.

Take a look at U.K. government bond yields, or gilts, which, at the time of writing, trade at a huge 100-plus basis-point premium to Italian BTP yields (let's not even look at the Bund-gilt spread for U.K. borrowing).

U.K. mortgages are priced off a range of factors, including swap rates, but underlying interest rates and elevated gilt yields, driven in part by concerns over government borrowing and the public finances, are an important part of the picture compared with equivalent mortgages in Europe.

In very crude terms, a critic might argue that the average U.K. mortgage (around £205,000 per household) is costing roughly £2,050 a year more than an equivalent mortgage for an Italian household. The comparison is illustrative rather than exact, but it highlights the broader point: higher borrowing costs have a real impact on households.

We can argue the toss about all the inputs into the extra cost of U.K. financing for everyone, from governments to corporates to consumers, compared with the Italians and others in Europe. But the fact remains that Andy Burnham cannot find a magic money tree to fund his plans from thin air.

So, while £45 off electricity bills sounds good, the real test of Burnham's premiership will be whether he can restore confidence in Britain's public finances. If gilts continue to trade at a steep discount to peers amid market fears of unfunded policies, the cost to households through higher borrowing rates could far outweigh the savings from a VAT cut.

Winning over voters is one challenge. Convincing the bond market may prove more consequential.