New PM must break us out of doom loop

Financial markets are febrile and each day brings fresh political convulsions. Yet, amid the garish headlines, do remain clear-headed about some underlying economic truths.

“We set out a vision for a low-tax, high-growth economy,” said Liz Truss, in her resignation speech on Thursday. “I recognise, though, I cannot deliver the mandate on which I was elected by the Conservative Party.”

The unshakeable political narrative is that the now comically misnamed “mini-Budget” of Sept 23 “crashed the economy”. This phrase, first coined by Labour, captures what is now the widely accepted view.

Even some Tory MPs, at least those determined to throw Truss out of office, have reinforced the idea that the outgoing Prime Minister presided over unhinged, deeply ideological policies. One accused Truss and her former chancellor, Kwasi Kwarteng, of “behaving like libertarian jihadists, treating voters as laboratory mice to carry out ultra, ultra free market experiments”.

This is arrant nonsense. The mini-Budget proposed lowering the top tax rate from 45 to 40 pence in the pound – where it was during almost the entire Blair-Brown era. The UK tax burden is heading for 36pc of GDP, the highest sustained level since the late 1940s. The Truss-Kwarteng plan was to bring it back to 35pc, where it was in 2021.

What spooked financial markets wasn’t a lower top tax rate – even though the timing of this policy, during a cost of living crisis, was politically crass. A 40p top rate was estimated to lower revenues by £2bn, a minuscule 0.2pc of the total tax take. Many economists reckon a lower rate generates revenue, by encouraging enterprise. That’s what happened when the top rate dropped from 50p in 2012.

What financial markets have worried about is the open-ended nature of the Government’s energy price cap – which began this month. After all, the cost of delivering a maximum unit energy cost to firms and households hinges on European wholesale gas prices. The bill could be tens of billions of pounds or nothing at all – depending on a host of military and geopolitical factors, not least the war in Ukraine.

Yes, the new Chancellor, Jeremy Hunt, last week announced the cap will now only apply until April, rather than two years as the mini-Budget suggested. But investors still want to know the nature – and potential cost

– of more targeted measures that will help lower-income households with their energy bills beyond next spring.

After Hunt’s Commons statement on Monday, the 10-year gilt yield – the benchmark government borrowing cost that ripples out across the rest of the economy, impacting mortgages and other consumer borrowing costs – fell from 4.1pc to around 3.9pc. Hunt was widely praised for “calming the markets”. But with questions swirling about the ongoing cost of the price cap, that same yield had returned to 4.1pc by the end of last week.

The reality is that borrowing costs faced by both governments and consumers have been steadily rising for some time, as we move away from the ultra-low interest rates we’ve had since the global financial crisis of 2008/09, kept in place by a torrent of quantitative easing (QE) – or newlycreated central bank money.

Prior to Covid lockdown, the QE billions remained largely within the financial system, pumping up stocks, bonds and other asset prices – not least housing. Covid-era QE, in contrast, was pumped directly into the economy via furlough schemes and business support loans – a big reason inflation has let rip.

The consumer price index in September was 10.1pc higher than the same month in 2021, we learnt last week – no less than five times the Bank of England’s target. This inevitable post-lockdown inflation surge means interest rates have been rising across the world for some time – and will continue to do so. The average UK mortgage rate soared from 3.6pc to 5.1pc between January and midSeptember, before the mini-Budget. Yes, that rate has increased more during recent market tantrums.

But the mini-Budget was the catalyst to a higher mortgage rate, by no means the underlying cause.

The pound is, similarly, on a long-term downward trend and was anyway set to spend time between $1.10 and $1.20 – as I wrote back in May.

One reason is because the Bank of England, behind the curve for months, has repeatedly increased rates more slowly than financial markets have expected. It was when the Bank raised rates by just 50 basis points the day before the mini-Budget, rather than the 75 point rise priced-in, that government borrowing costs really spiked.

With the US Federal Reserve imposing successive 75-point increases, the dollar, benefitting anyway from “safe haven” reserve currency status, is sucking in capital from around the world. All major currencies are falling against the greenback, not just the pound.

Britain, though, is perhaps uniquely vulnerable – given that we have very limited gas storage, so this winter may have to rely on highly volatile and potentially hugely expensive spot markets to prevent blackouts. This is another long-term reality that worries those looking to invest in UK Government debt and our currency.

Britain also suffers from a more widespread import dependence. During the first quarter of this year, our trade deficit of goods and services widened from £14.9bn to £25.2bn

– the largest quarterly shortfall on record, with net trade acting as a drag on growth. Since then, our trade position has barely improved, given the UK’s ongoing reliance on expensive energy sourced from abroad.

This gaping external deficit also weighs down the pound, which then drives inflation as our copious imports become more expensive, adding to a “doom loop” as sterling falls even more.

These are deep-seated, ingrained trends, driven by years of poor decision-making relating to QE, interest rates, energy planning and a host of other issues. Yes, our budgetary position is precarious – borrowing in September hit £20bn, significantly higher than expected.

But we still need to “go for growth” – and finally escape the low productivity and ever-rising taxation that has for years stifled the enterprise and broader wealth creation upon which everything else, not least the funding of public services, depends.

Whoever succeeds Truss will face the same fundamental issue that she faced – how to break Britain out of the high-tax, cheap-money, low-growth stagnation of the last decade of decline.

‘The mini Budget was the catalyst to a higher mortgage rate, by no means the underlying cause’