The markets have tasted blood and are eager for more. Liz Truss has sacked Kwasi Kwarteng as chancellor and ditched another piece of the mini-budget announced less than a month ago, but she now faces another week in which financial turmoil and political intrigue create a toxic mix.
Monday will be a crucial day for the prime minister. If sterling heads towards parity with the dollar and rising bond yields put upward pressure on mortgage rates, Truss may soon be handing in her resignation to King Charles.
The signs are that the U-turns, the sackings and the reassurance won’t be enough. The Bank of England bond-buying scheme came to an end on Friday and Threadneedle Street is in no mind to restart it. Its intervention was all about providing pension funds with breathing space and it now believes they are more resilient as a result. The test for further Bank action is whether there is financial instability – a systemic threat – not whether there is market instability.
Jeremy Hunt has been doing his best to reassure the hedge funds that have been targeting UK assets that there is now a firm hand on the tiller. Difficult decisions on tax and spending will be necessary in the fiscal event planned for 31 October, he insists.
But the fact that Hunt is the fourth chancellor since July tells its own story. Even in the toughest times in the past, the UK had a reputation for political stability, but that reputation has been shredded.
Finance ministers and central bank governors attending the annual meetings of the International Monetary Fund and World Bank in Washington last week could scarcely believe what was happening on the other side of the Atlantic. The turmoil in the UK bond markets affected interest rates in the US, to the intense irritation of the US Treasury secretary, Janet Yellen. The UK – as one of those attending put it – was not flavour of the month.
The travails of the Truss government were really only a subplot to the main story in Washington – the far-reaching ramifications of the war in Ukraine. With no prospect of peace, the economic message was grim. Higher energy costs have pushed up inflation to 40-year-highs in many countries and central banks are being urged by the IMF to carry on tightening policy until cost of living pressures abate.
In the face of this squeeze, Truss and Kwarteng had a reasonable case to make. They could have said the flipside to the solidarity the public has shown towards Ukraine has to be generous compensation for the war’s economic consequences: dearer energy and falling living standards.
They could have said that when monetary policy is being toughened up by the Bank of England it makes sense to use fiscal policy – the tax and spending decisions taken by the Treasury – to mitigate the risk of recession. They could have said it makes sense for a government that issues its own currency to borrow more in the current exceptional consequences.
Indeed, had Truss and Kwarteng simply announced details of their energy package last month and left the tax cuts promised by the prime minister in her leadership campaign for a budget in November they would have escaped unscathed. There would have been some grumbling from the IMF about the need for targeted support but the government would have been able to ride that out. Instead Truss has received zero credit for an energy price cap that is twice as generous as the average EU package.
The reason for that is simple. She thought there would be no comeback if she sacked the top mandarin at the Treasury, surprised everybody by including the abolition of the 45% income tax rate and the scrapping of the bankers’ bonus cap, and dispensed with scrutiny by the Office for Budget Responsibility.
This was a series of terrible errors, further compounded by Kwarteng going on TV on the weekend after his mini-budget – when there had already been adverse market reaction – to boast of more tax cuts to come.
It has been retreat all the way for Truss ever since and it no longer really matters whether she stays or goes because the forces of orthodoxy – spearheaded by the financial markets – are back in control.
Britain has had its share of financial crises but in the future this will be seen as the example of how not to do things. Black Wednesday – the moment in September 1992 when the pound was blown out of the European exchange rate mechanism – is usually seen as a moment of national humiliation that would prove impossible to beat. Truss has proved otherwise.
What’s more, there is not even a silver lining to her omnishambles in the way there was after Black Wednesday. Sterling’s departure from the ERM allowed interest rates to be cut and the pound to fall, boosting the economy’s growth prospects and laying the foundations for a period of expansion that lasted a decade and a half.
Truss’s botched attempt to challenge the orthodoxy has already led to higher mortgage rates. It will now result in spending cuts, a deeper recession, and a new era of austerity as the government seeks to restore its credibility in the markets.
There is already a shift of emphasis from “growth, growth, growth” to “sustainable public finances” and it won’t be long before we are back to “if it isn’t hurting, it isn’t working” and “there is no alternative”.
That’s not true. There are alternatives. The real tragedy of Truss is that she has made it harder for those who support active fiscal policy, borrowing to invest and price controls as an anti-inflationary weapon, to get a hearing.