Telegraph e-paper

Gilt market tremors herald worse to come – and not just for the UK

JEREMY WARNER

According to the “Juncker curse”, named after the former president of the European Commission, Jean-claude Juncker: “We all know what we have to do, we just don’t know how to get re-elected once we have done it.”

Few ruling politicians will be more acutely aware of Juncker’s warning right now than Britain’s Liz Truss and her Chancellor, Kwasi Kwarteng, after one of the most brutal receptions for a new Government’s economic agenda we have seen in decades.

Their poll ratings plummeted, the pound dipped close to parity with the dollar, interest rates spiked disastrously upwards, the International Monetary Fund issued a stinging rebuke, and the measures very nearly triggered a full scale financial crisis. To call it a baptism of fire is an understatement.

Both the markets and the voters have taken violently against their “plan for growth”. At this juncture, it is hard to see how they are going to turn things around. As one seasoned City observer only half jokingly puts it: “The only thing still holding the markets up is the growing certainty of a Labour victory at the next election.”

There are no good options left. Either Truss and Kwarteng stick to their guns, in which case further steep rises in interest rates become inevitable, spelling calamity for overstretched mortgage holders and a housing market crash to match; or they do a screeching about-turn, which would destroy what little political credibility they have left; or they impose deep austerity by finding the spending cuts that would match their present unfunded tax pledges.

It seems to be this latter course that they are belatedly trying to cobble together. Good luck with surviving the political fallout. The Red Wall, a key component in their current parliamentary majority, is crumbling before their eyes.

Fortunately for them, the election is two years away. The more immediate challenge is restoring credibility in markets after the bungled nature of last week’s mini-budget. Against an extraordinarily depressing outlook for the global economy, this is going to be an uphill struggle. Once credibility is lost, it’s very hard to win back.

Friday’s meeting of the chairman of the Office for Budget Responsibility (OBR), Richard Hughes, with the Prime Minister and the Chancellor was mainly about procedure, or the sequencing of forecasts to prepare for November’s further fiscal statement.

It’s what should have been done before the mini-budget; instead, Downing Street took to the skies without first going through the aeroplane’s safety checks. Just to extend the analogy, the plane crashed because they had first removed the altimeter.

Not much occurred at the OBR meeting beyond agreeing to reinstate previously established ways of assessing the Government’s plans. But in order to flesh out the forthcoming debate, here is my imagined account of what a full and frank exchange of views might have sounded like.

Truss: “Now listen, Richard, we need you to produce an assessment that makes our plans look acceptable to markets, so it would be helpful if you simply assumed our target for trend growth of 2.5pc will be met. This would solve the problem, n’est-ce pas?”

Hughes: “No can do, Prime Minister. The markets would not see such a forecast as credible, however much they might admire the ambition of your supply side reforms, so it wouldn’t do the trick and would make the OBR look like Downing Street’s patsy.”

This avenue denied, the Chancellor would then inquire what scale of spending cuts would be required to make the numbers add up. About £50bn a year might just about hack it, would have come the answer.

Some of this could be achieved by freezing spending plans, thereby allowing elevated inflation to do the work by eroding spending in real terms. This would still feel like austerity in spending departments, particularly health, but needs must. As for the promised increase in defence spending to 3pc of GDP, this presumably has already gone up in smoke.

The other already hinted at target for cuts is entitlement spending, including the state pension, much of which is indexed to inflation.

That abandoning this link would mean tearing up another manifesto pledge – to maintain the triple lock on pensions – is neither here nor there against the wider politics of such action.

Truss has said she is prepared to be unpopular, but this would be something else. To be bearing down on entitlements while axing the top rate of income tax … well, as Sir Humphrey would have said: that would indeed be brave. Others might call it political suicide.

Politics is about the art of the possible, not the pursuit of some theoretical ideal, which in practice can never be delivered and in any case is completely useless if it fails to get you re-elected. Two years, the time left before Truss must face the voters, is not enough for the agenda to deliver as promised. In the meantime, she risks being politically crushed by the pain of implementation.

As it is, Downing Street has almost deliberately gone out of its way to offend the markets, and is suffering the consequences. What did it expect? To launch such an ideologically driven agenda against the backdrop of extraordinarily fragile financial markets – with more than a decade of ultra-easy monetary conditions going abruptly into reverse and an unprecedented combination of demand and supply side shocks piling in on an already weak global economy – was asking for trouble. To do so, moreover, without thought for the countervailing spending cuts that might be needed, and while refusing to subject the proposals to OBR assessment, was borderline reckless.

Compounding the sense of a Government that had no idea what it was doing was the public guillotining on day one of the Treasury’s most experienced firefighter at times of economic crisis, Tom Scholar.

Having comprehensively trashed them on the campaign trail, the new Government is being forced to learn the hard way about the merits of established “orthodoxies”, including a fiscally conservative Treasury and an independent Bank of England and OBR. Rightly or wrongly, they are vital to market credibility.

And they are especially important today, with the entire financial system destabilised by years of post-financial crisis central bank money printing.

Last week’s shenanigans in the UK gilts market provided a brutal reminder of just how precarious things have become, with the Bank of England having to embarrassingly reverse its plans for quantitative tightening and instead resume asset purchases so as to head off a “doom loop” of gilt-selling by pension funds.

Our addiction to debt – with households and governments over borrowed in equal measure – is now so great that it may be that central banks are no longer capable of taking the tough actions needed to get on top of inflation.

The mistake Truss has made is to think that because it was apparently so easy to fund the largesse of the Government’s Covid response, markets would not baulk at another £45bn of tax cuts. But Covid, and indeed today’s £150bn energy support package, are one-offs. The tax cuts are permanent and structural, and have proved the final straw. Last week’s tremors in the gilts market are, I fear, just a harbinger of much worse to come. And not just in Britain.

‘To launch such an ideologically driven agenda against the backdrop of fragile financial markets was asking for trouble’

Front page

en-gb

2022-10-02T07:00:00.0000000Z

2022-10-02T07:00:00.0000000Z

https://dailytelegraph.pressreader.com/article/281560884676898

Daily Telegraph