Treasury orthodoxy is back. After a “small” Budget terrifies the market and sinks gilts, reassurance is the mantra. Over the past week, the Truss government, which has spent the summer denouncing the wrongdoing of the economic establishment, has gone too far to delve into the agencies it blames for the UK’s decline.
After criticizing and shutting down the Independent Office for Budget Responsibility from last month’s scandalous and rushed fiscal statement, prime minister Kwasi Kwarteng has now made it the arbiter of the entire fiscal strategy. mine. The the highest-ranking official at the Treasuryselected to replace the facility veteran who was laid off a month ago, after all it won’t be a dynamic, non-mainstream but one man spent most of his career there. The Bank of England made three interventions in two weeks to strengthen the gold plating market. The Truss institution that was once in ruins now holds a mortgage for her future.
The medium-term fiscal plan – part of the government’s tax-cutting strategy – was launched at the end of October, to proceed with the Bank’s next rate-setting meeting in hopes of an overshoot. Tax cuts, the abolition of the highest political tax rate, even the smallest politically, were ignored in the face of a protest uprising. Truss is now reaching out to MPs.
The Prime Minister has not abandoned his core strategy of borrowing to cut taxes. “We need to work closely with the OBR but we are not backing down. We need to do things differently,” said a close ally. But she reluctantly accepted that credibility required more than the challenge of stabbing a finger into the Laffer curve.
Some Tory critics are encouraged by the change of tone. Mel Stride, a former Minister of Finance, discovered “a fundamental shift towards reconciliation between the party and supporting institutions”. Others are less optimistic. One former minister said: “I don’t see a way out of this.
For this reset may no longer be enough. The restart of the Truss government was driven by a vicious cycle of five Grandmothers – money, markets, mortgages, majority, and powers.
First, money: the government ran a deeper deficit with tax cuts it couldn’t afford while spending tens of billions on an energy rescue package. Meanwhile its interest expense is increasing. To meet OBR and market hopes, the Institute for Fiscal Studies says Kwarteng must find up to £60 billion new tax cuts or increases.
Kwarteng’s aim was to devise a five-year deficit reduction strategy with the harshest savings accruing to the end of that period once, ideally, GDP growing. The risk here is that neither the OBR nor the market will be impressed by growth projections or the promise of low savings, while Tory MPs will fear an election taking place in the shadow of the cuts. .
The market has reacted to gaps in public finances. But what is more worrying is that investors are now seeing the UK as an outlier among Western economies. Among G7 countries only Italian 10-year Treasury have higher productivity. Once a country separates from the group, it becomes more exposed.
This leads to mortgages. Even as the government’s tax cut promises to put more money in people’s pockets, it is putting many in the way due to rising interest rates. Millions of homeowners with mortgages or loans have to pay off a huge increase every month. While GDP growth is an abstract concept to voters, the impact on household budgets is frighteningly real.
This strained the nerves of difficult and fearful Tory MPs and the fact that, despite her opinion parliamentary majority of 69, Truss actually doesn’t have a majority. The mood is dreary, not least among the multitude of ex-ministers removed. The loss of confidence in the prime minister’s ruling and the horror fueled by plummeting opinion polls make it difficult to push through controversial reforms. Few believe she has the votes to cut the actual condition for benefits ministers are considering. Truss was not nationally elected and supported by less than a third of her MPs. This lack of personal mandate means MPs elected under Boris Johnson’s manifesto are less apprehensive about rebelling.
This completes the negative loop: political turmoil deepens market concerns as it raises doubts about Truss’ ability to save. The unchangeable law of politics – a law well understood by the market – is that no prime minister, no matter how worthy they may be, can become an effective long-term leader without money, no majority and no mandate.
She must invite her MPs to reassure the market. But one requires the other, and few could see the massive change that turns this vicious circle into a virtuous circle without Kwarteng’s overly harsh correction. So everything is on the financial plan, which is being rushed together and still has three weeks to go. This requires a level of political and financial acumen hitherto unheard of in this position of prime minister.
Unless they find new ways to increase revenue, it may just take a big pullback on some tax cuts (probably corporate taxes) to restore market confidence. But it was a last resort for Truss. It would create its own political crisis and could entail the firing of the prime minister. She is really attracted. One former minister argues she needs a piece of luck, a game-changing global event. Alas, Truss doesn’t look glamorous and besides, luck isn’t a plan.