This article should take a considered look at whether or not this mini-budget will generate the promising growth.
It should be about whether it makes sense to borrow so much money to finance it tax cuts and whether this economic gamble (for a gamble it is) will actually work out.
And in one sense, it’s still about all of those things, but for the most part, it’s about the extraordinary response of the financial markets.
Stamp duty, energy bill and alcohol tax – important announcements in the mini-budget
I can’t recall any other fiscal event that triggered such a reaction: the hit down very hard; Gilt yields (the government’s cost of borrowing) rose more than any other day in modern records; Equity markets down and money markets point to a painful rise Bank of England interest rates in the following months.
You can dismiss it all as the whining of the men in gray suits, except that it matters.
Think about it for a moment: the UK government just committed to borrowing enormous sums to fund a series of tax cuts. It has done so in the hope that this will generate additional growth and take Britain’s disappointing productivity trajectory to a new level.
There is a certain logic to that, and we can discuss whether today’s mini budget has made the right reforms, but more important than all of that is the ability to borrow all that money, which in turn goes back to these international capital markets.
And the message from these capital markets is not encouraging. The reason government bond yields have risen so much is because investors believe we are riskier than we were in the morning. They want to charge us higher interest rates, like any lender will with a heavily indebted borrower.
But the direct result of that is in the hours after Kwasi Kwarteng sat down, those borrowed funds, worth hundreds of billions of pounds, immediately became much more expensive.
Pound’s decline is perhaps more worrying. Don’t get me wrong, we’ve had our fair share of rough days for sterling and that’s nothing compared to the night of the EU referendum.
We survived this – even if the pound never recovered – why not shake it off?
And indeed, the sterling could well recover in the coming days and things will look a little less gloomy.
Still, consider what these currency moves mean: that’s a lot of investors pulling their money out of this country, choosing not to invest money in the UK, pulling out rather than diving in.
If these investors were enthusiastic about the UK growth plan, you would expect them to want to be part of it; You would expect them to start allocating money to investments in the UK; instead the opposite seems to be happening.
In short, the verdict is not particularly encouraging. No other budget of modern times has seen such a reaction. Perhaps the closest analogy is the budget to which this has already been compared: Anthony Barber’s 1972 budget.
This was another attempt to stimulate economic growth a few years before an election; it ended badly, with a monetary and fiscal crisis, and Inflation explodes up to two digits.
Well, in some respects the territory today is very different from the 1970s. For one thing, the pound is happily floating while it was teetering around in the early 1970s at the end of the Bretton Woods era.
One could even argue that today’s sterling decline is a sign of success: as times change, our currency will adapt. Another difference is that the Treasury no longer decides interest rates; these are set up by the independent Bank of England on the other side of town.
But this is where things get uncomfortable again. The bank is obliged to strive for financial stability. It’s the pound’s keeper.
If sterling falls further, the possibility of the bank intervening with a rate hike cannot be ruled out. Some economists believe this could happen as early as next week; in fact, that’s pretty much priced in by the money markets.
These markets are betting that interest rates will rise to 5.5% next year. That’s almost a percentage point more than they expected before Mr. Kwarteng got up.
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Interest rates at that level would be higher — taking into account people’s mortgage debt — than anything we’ve seen since the late 1980s, when the housing market was headed for its biggest crash in modern times.
It’s not a happy precedent, but that’s what markets are betting on now.
The next few days could be bumpy. The hope is that the pound will recover in the coming weeks, but there is also a possibility that it will fall further. This is not yet a crisis. But it doesn’t look particularly good.
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