Febrile markets are a test for the new PM
The Bank of England moved yesterday to calm the turmoil that has engulfed the pound since last Friday’s mini-budget, declaring its willingness to take on the markets by buying up bonds. The Bank’s intervention, which followed a gratuitous reprimand from the International Monetary Fund for the Chancellor’s tax-cutting package, was partly motivated by fears of a pension fund crash – yet another element in a rapidly unfolding situation.
It has obviated, for now, the need to put up interest rates again just a week after the last increase. That would have been an acknowledgment that the 0.5 per cent rise – less than the markets had expected – was too weak a response. The Monetary Policy Committee decision, followed by the Government’s financial statement on Friday, led to pressure on the pound and a sharp rise in the cost of government debt. While this is not a uniquely British problem, the markets appear to have homed in on sterling.
The Bank stated it had acted to stabilise what it called “dysfunctional markets” without which there would be “a material risk to UK financial stability”. To say this a serious blow to its credibility would be an understatement. It is a challenge for the Government too: just weeks into her term as Prime Minister, Liz Truss faces a financial crisis that must be gripped with haste.
But amid all this upheaval, one thing should be said: the Government’s policy to prioritise economic growth is the right one and should not be abandoned. The world is heading into recession and the UK needs to be ahead of the game, with lower taxes and supply-side reforms the best way to keep the wolf from the door.
This newspaper has argued for years that such a plan was needed, but it comes with an important caveat: that the spending side had to be addressed as well. We live way above our means as a country, sustained by ultra-low borrowing costs on the domestic front and an institutional resistance to any retrenchment of the state. Yes, there is a squeeze on departmental budgets – they are being held down, and with inflation at 10 per cent expenditure will fall as a proportion of GDP. But much more still needs to be done.
A root-and-branch review of what the state does in order to rein in its inexorable expansion should have happened years ago. Reforms to the NHS, care and welfare to account for a rapidly ageing population are essential but have been resisted by politicians whose eyes are always on the next election rather than the long term, and who are prepared to rack up debt in pursuit of votes.
The shocks of the past few years have seen the chickens come home to roost. The pandemic and Russia’s invasion of Ukraine have left countries including the UK vulnerable to market turmoil. It was not a mistake to try to set a course for growth last Friday, yet the mini-budget was seen, fairly or otherwise, as a display of cavalier insouciance to the state of the public finances.
With the dollar strong, inflation high and the markets in a febrile state, the financial statement the Chancellor is promising for November should take a more holistic approach.
There was always a risk, given the anti-brexit sentiment still in evidence in the global financial sector, that the markets would target the UK for taking a radical approach. The hope is that the Bank’s intervention will calm things down but the fact remains we are heading into turbulent waters, with the prospect of interest rates rising to 5 per cent or more, seriously hurting highly leveraged borrowers no longer able to afford repayments.
Despite calls for a volte face, Ms Truss has no real alternative but to keep her nerve and plough on. But the wider Cabinet have to show they understand the need to restrain spending and not put the entire burden for funding outgoings onto borrowing to be paid for by future generations. A spending review that requires every extra pound to be justified would be a start.
This has been a testing start for the new Prime Minister. Following the death of the late Queen and the subsequent mourning period, she has struggled to communicate her immediate agenda to the public. The party conference next week should provide her and the Chancellor with a platform to explain their policies, not just to the general public but the markets too.