How Kwarteng can win back the Square Mile

The new Chancellor is a City veteran. And there are three ways he can get his old colleagues back onside, writes Matthew Lynn

Kami-kwarsi. Daggers, slang for two stops past Barking. Or the return of the Great British Peso, plus the launch of a new cryptocurrency called “S---coin”.

In one respect at least, Kwarsi Kwarteng’s “fiscal event” last week and the tumultuous ride in the financial markets that followed it cheered up the City. There was lots of opportunity for jokes, and there is nothing the traders and dealers of the Square Mile love more than some quick-witted banter.

In every other way, however, the Chancellor’s reputation, and that of his boss Liz Truss, has sunk like a stone. The pound has slumped, the FTSE is weaker than it was 22 years ago, the UK’S credit rating has been cut and the Government’s reputation for economic competence, such as it was, has already evaporated.

Can Mr Kwarteng ever rebuild his relationship with the banks and investment funds? It is not going to be easy. Ending the cap on bankers’ bonuses clearly won’t be enough, nor will scrapping the 45 per cent top rate of tax that fell mostly on the often extravagantly paid financiers, make any difference either.

Even so, there is still the chance to build bridges. The Chancellor may claim that scrapping pay caps would “reaffirm the UK’S status as the world’s financial services centre” but there is a lot more he needs to do before his mission is successful.

Setting out a clear plan for putting the public finances on a sustainable path will clearly help. So will removing the restrictions the European Union has placed on the financial sector, as well as embracing the technologies that will allow the City to flourish. In the end, however, there is only one strategy that will really work.

Namely, delivering the kind of meaningful supply side reforms that actually make a difference – and that is going to be very difficult when there are only two years left before a general election.

Contrary to what the Left would have you think, Conservative chancellors and prime ministers don’t always have the best relations with the City. In the Eighties, Nigel Lawson, the then Chancellor, dismissed banking analysts critical of his policies as “teenage scribblers”. Edward Heath described Tiny Rowland, the buccaneering Seventies tycoon – then a hero of the markets – as “the unacceptable face of capitalism”.

Just because the traders and speculators who make up the financial sector are often referred to as “the markets” it is a mistake to think that they have any special attachment to free-market liberalism.

In reality, banking has always been one of the most heavily regulated, least competitive sectors of a capitalist economy, dependent on governments to keep it afloat, and often instinctively hostile to any form of liberalisation.

Even so, Mr Kwarteng might have hoped for a more sympathetic hearing. With spells at JP Morgan Chase, Westlb and Odey Asset Management before becoming an MP, he has, like his two immediate predecessors Rishi Sunak and Sajid Javid, a background in finance. And yet he appears to have badly misjudged how the people he used to mix with every day would react to his policies.

Last week, the Swiss investment bank UBS described the Tories as a “doomsday cult”, while the research firm TS Lombard coined the term “moron risk premium” to describe Britain’s increasingly perilous financial position.

That is way beyond the normal scrutiny that any government can expect from the investment banks. It is all-out war.

So what should Mr Kwarteng be doing to try to turn that around? It won’t be easy – but here are three places he can start.

Get the Bank on side

First, stop picking fights with the main City institutions.

The Bank of England has hardly covered itself with glory over the last decade. Inflation is, after all, running at five times its target rate, while the emergency intervention last week was mainly designed to prevent a collapse in instruments used by pension funds that should have been better regulated in the first place.

Last week, the Chancellor said the Treasury was “working closely together” with the Bank and that bi-weekly meetings with Andrew Bailey, the Governor, had been replaced with daily communications.

The City will want to see that he has achieved more than just talking.

Likewise, the Office for Budgetary Responsibility (OBR) hardly adds anything meaningful to the debate on public spending, and its instincts are to defend the status quo even when it is clearly not working.

And yet, this is not the moment to take them on, or to ignore their advice.

As he sets out his spending plans in more detail over the next month, Mr Kwarteng will need to bring the Bank and the OBR with him.

And if he does so, the ratings agencies and the main investment banks will gradually follow their lead.

Embrace Brexit and scrap rules holding back the Square Mile

Next, start reforming the City so that it can flourish outside the EU. Lifting the bonus cap imposed on London by Brussels was never going to be popular, but it was still the right thing to do. And yet that should surely just be the start.

There are a whole series of EU regulations that could be lifted, such as the cumbersome “Mifid II” rules (so complicated hardly anyone can understand them) and the ridiculously complex solvency rules, alongside the raft of new Environmental, Social and Governance guidelines that are about to be imposed on every investment product regardless of whether they make sense or not.

The UK should also embrace new technologies such as AI, instead of clamping down on them as the EU does. Historically, the Square Mile thrives when it has the freedom to innovate. Once it starts to see Mr Kwarteng as the man delivering new opportunities, the mood will start to change.

Boost economic growth

Finally, focus on the hard work of structural reform. In the end, there is only one thing that will get global investors interested in the UK again – results.

True, very few of the banking analysts, and certainly not the IMF and the World Bank, believe any more that lower taxes and lighter regulation can increase growth. But they can be persuaded by the evidence. Over the next year, the Government will have to launch round after round of reforms to raise the growth rate. The investment zones will have to offer genuinely lower taxes, as well as lifting restrictions on planning, if they are to have a chance of working.

Welfare reforms will have to encourage people back into work over the next few months. Fracking should be started immediately, both to increase energy security, and to create well-paid jobs as well as bringing in extra tax revenues.

If the City analysts can start to see fracking taxes rolling in – and lower welfare spending as more people enter the workforce – they will have to revise their fiscal forecasts. And then the Chancellor won’t look so crazy.

On Thursday last week, Mr Kwarteng met with senior figures from the City including Jpmorgan, Citigroup, Deutsche Bank, Morgan Stanley, Standard Chartered, Bank of America, and UBS, along with the London Stock Exchange and representatives from Aquis Exchange, Intercontinental Exchange, the London Metal Exchange and Bloomberg.

A charm offensive is clearly under way to try to repair the damage.

True, a Chancellor doesn’t necessarily need the support of the City. It doesn’t have a huge number of voters, and endorsements from its leading figures won’t help the Conservative Party at the polls. A fight or two won’t necessarily do any long-term harm.

Even so, with the Government still borrowing unprecedented amounts of money, and with the currency and bond markets still volatile, Mr Kwarteng will need as many friends as he can get. Enthusiastic support from the financial sector would make the task ahead a little easier – even if right now it does not look very likely.

‘As he sets out his spending plans, he will need to bring the Bank of England and OBR along with him’

‘The Square Mile thrives when it innovates. The mood will start to change when he delivers opportunity’