The dangerous charge for the government – and the one that should alarm backbench Tory MPs as they watched sterling swoon – is the basic one about competence. Are Liz Truss and Kwasi Kwarteng capable of getting their “new era” for the UK economy off the launchpad? Do they understand that, when you’re running a large current account deficit and need to borrow the thick end of £200bn next year, financial markets matter?
The prime minister and chancellor might have expected a bumpy reception, but what they got was an open revolt in markets and some extraordinary comments from grown-up economists at serious firms. “Hope is not a strategy,” said Nomura’s team, predicting parity for the pound against the dollar by year end. “Investors seem inclined to regard the UK Conservative party as a doomsday cult,” said Paul Donovan at UBS Global Wealth Management.
While Monday morning’s record low against the dollar grabbed the headlines, sterling has also fallen about 8% on a trade-weighted basis in two months. That is a chunky move, but one dwarfed by what’s happened with gilts. It cost the government 1.9% to borrow for 10 years in early August; that rate was 3.1% a week ago and is now 4.1% as the market tries to work out how far the Bank of England will have to raise interest rates. Virtually nobody accepts the notion that the biggest tax cuts since 1972 can be anything other than inflationary.
Fans of Trussonomics can argue all they like that tighter monetary policy is part of the grand design, but the short-term effect of these violent market movements is that two key giveaways in Friday’s mini-budget – the cut to 19p in the basic rate of income tax and the reduction in stamp duty – will be swamped by higher-for-longer inflation and an inevitable rise in mortgage costs.
One can think of at least three ways in which Kwarteng and Truss could have pitched things differently. First, what was the point of abolishing the 45p higher rate on income tax? It was a modest measure – about £2bn – but it cemented the narrative about a budget for the rich and has drowned out any feelgood factor in the cut in the basic rate. And why bang on about removing the cap on bankers’ bonuses? There is a sound argument to ditch the cap (it just inflated salaries, as argued in this column the other week), but the politics are toxic.
Second, the decision to gag the Office for Budget Responsibility on day one has backfired spectacularly. Presented with £45bn of fiscal loosening in one gulp and no news on government spending, investors would obviously want to know what the budgetary watchdog would say. You cannot simply assert that you are “determined” to improve the trend rate of growth to 2.5% and expect applause. It was no accident that the Treasury, grasping for something to say late on Monday afternoon, put a date on when the OBR will be allowed to speak (23 November).
A third unforced error was made during the Tory leadership contest, when Truss made her airy comments about reviewing the Bank of England’s mandate. In office, she and Kwarteng have tried to row back by championing the Bank’s independence, but suspicion of an undeclared war with Threadneedle Street lingers.
This is the same Bank, though, that the government is now relying upon to reassure markets. Rightly or wrongly, every decision by the monetary policy committee will be filtered by outsiders through a political lens. The Bank’s own afternoon statement was weak: no emergency hike in interest rates, just a line about how they “will not hesitate” at the next scheduled meeting. It may succeed in turning down the market volume for a while, but you wouldn’t bet much on that outcome. The precise interaction between the Treasury’s loose fiscal policy and the Bank’s tighter monetary policy looks an exercise in making things up on the hoof.
International investors cannot be blamed for being shocked. To the extent they followed the Tory leadership contest, they will have gleaned that the candidate who came third in the first four rounds of voting by Tory MPs (Truss) was merely planning to scrap the rise in corporation tax and reverse the increase in national insurance contributions.
Friday’s grand tearing-up of economic orthodoxies, just as public borrowing surges to pay for the energy crisis, was not advertised in detail. Beyond a bit of thinktank theorising, there was no serious attempt by the new administration to lay the groundwork with markets. A lot of financial credibility has been shredded in just two trading days. The political naivety is staggering.