Blame QE monster for market meltdown

The UK has the second lowest ratio of debt to GDP of the G7. Headline inflation, while elevated at 9.9pc, is below the eurozone average. On top of that, Britain isn’t in recession as feared. The economy grew 0.2pc during the three months to June, the Office for National Statistics reported on Friday, reversing the previous estimate of a 0.1pc contraction.

But despite the UK’S relative economic strength, we’ve had a week of headlines and bulletins telling of financial meltdown and economic Armageddon. Given the market gyrations of sterling – and long-term interest rates – such headlines are not wrong.

Yet much of the media analysis of the Government’s “mini-budget”, and the reasons behind the plunging pound and spiking gilt yields, has been simplistic and misleading.

The “unfunded tax cuts” outlined by Kwasi Kwarteng on Sept 23 have been widely blamed for driving sterling to an all-time low, while pushing up borrowing costs.

As mortgage providers have pulled new loans, analysts have warned of a housing bloodbath – with those looking to refinance home loans exposed to much higher, possibly unaffordable, interest rates. This week of financial turmoil has left millions frightened and angry.

While Kwarteng’s statement sparked last week’s alarming debt repricing, it was by no means the underlying cause. There are far bigger forces at play.

Blaming the Tories is a straightforward, compelling narrative – an off-the-shelf consensus, which Sir Keir Starmer exploited at his party conference in Liverpool. The Government “crashed the pound”, the Labour leader declared – a conclusion almost no journalists sought to challenge. But the reality is more complex and more worrying. For what we have seen since Kwarteng’s statement was just the beginning of a long-term shift away from over a decade of ultra-low interest rates and quantitative easing. We’ve indulged in ultra-loose monetary policy since the 2008-09 financial crisis – a necessary emergency measure, which ossified into a lifestyle choice. And now, the obvious excesses, dangers – and crass stupidity – of this policy, are coming home to roost.

Since that financial crisis, the Bank of England has created hundreds of billions of pounds of QE money, as have similarly aligned central banks, which have blown huge asset price bubbles in stocks, bonds and property. QE has helped governments borrow cheaply, while making the rich even richer – which is why, having begun as a £50bn temporary measure to inject liquidity into bombed-out banks, it has morphed, 13 years on, into an £895bn monster.

The early tranches of QE stayed largely within the financial system – so didn’t cause serious inflation. But the Covid-era variant, funding furlough and an avalanche of business support loans, has fed directly into the real economy – helping to explain today’s inflation predicament.

This is an inconvenient truth that no one wants to admit – certainly not the likes of the International Monetary Fund and central bankers who oversaw QE. Better to blame an incoming Tory government – one led by a politically vulnerable Prime Minister, with only lukewarm support from her own MPS.

Don’t get me wrong – there was much to criticise in this mini-budget. To lower the top “additional” tax rate from 45pc to 40pc as the cost of living squeeze tightens was ill-judged. Announced on the eve of Labour’s party conference, the timing of this tax cut for the richest 2pc could not have been worse.

But the idea that this “unfunded cut crashed the pound” is preposterous. Yet that is now the accepted political narrative – that a greed-driven Tory policy collapsed sterling and sent 10-year gilt yield surging as fears swirled of government insolvency, sending higher borrowing costs rippling across the economy, damaging hard-working families and firms. What I suspect happened is that global currency traders, understanding the top tax cut was politically tin-eared, could see ministers were in for a kicking. With the Government introducing a potentially expensive energy price cap, the moment seemed right to start shorting – that is, betting against – the pound, knowing the media would pile in.

When that happened on Asian markets on Monday, and we woke to a plunging currency, I was astonished that ministers fell silent – given the strength of the arguments on their side. When George Osborne lowered the top rate from 50pc to 45pc in 2012, the Treasury reaped more, not less money from wealthy earners. For almost the entire New Labour era, the top rate was 40pc. While ill-timed, this was hardly a radical move. More fundamentally, the vast majority of the mini-budget tax cuts were trailed, with Truss having campaigned on pledges to reverse Rishi Sunak’s 1.25pc National Insurance increase and keep corporation tax at 19pc, scrapping the rise to 25pc. These two widely expected moves accounted for £38bn of the £45bn of cuts confirmed by Kwarteng.

Would an additional £7bn of new tax reductions – including the changes to stamp duty and IR35 rules, as well as the lower top rate – threaten the UK’S solvency? I think not.

All major currencies have fallen against the dollar – not least as the Federal Reserve has implemented three 75 basis point interest rate rises in successive meetings to stamp out inflation. And at least part of the reason the pound was vulnerable was that the Bank of England, ignoring the Fed, raised UK rates just 50 basis points the day before the mini-budget, having misdirected financial markets once again.

As years of bubblenomics start to unwind, rates are rising and financial markets are retrenching, causing the “safe haven” dollar to surge. Central banks in Indonesia and Japan are now defending their currencies. The Bank of Korea is hoovering up huge chunks of Seoul’s sovereign debt.

For now, the Bank of England’s intervention on Wednesday – buying gilts to rein in borrowing costs – seems to have worked. By Friday, the pound was back where it was pre-statement, the 10-year yield having retreated from over 4.5pc to around 4.0pc.

But the City and Wall Street moneymen, having loaded pension schemes with billions of pounds of debt, yet again have the upper hand – effectively forcing the UK authorities to restart the QE asset-boosting machine. This cannot end well.

“Tory tax cuts”. It’s such an easy and convenient scapegoat. The truth is we’re in for a sustained period of painful adjustment – one that our political and media class must urgently start to explain.

‘Currency traders, realising the top tax cut was politically tin-eared, could see ministers were in for a kicking’