For those of us who usually comment on Trussonomics, there has long been an assumption that Truss and Kwarteng are keen on higher interest rates. As Kate Andrews put it In a tweet this morning, the Truss government “wants interest rates to rise faster” as it is a “key element of its new economic strategy”. Monetary tightening to counter fiscal easing.
In this case, the frantic market reaction to the mini-budget – if it forces the Bank of England to raise interest rates faster than it has done so far – is a blessing in disguise. While most of today’s coverage has focused on the pound’s yo-yo to and then off a record low, the bigger story today is rising gilt prices and growing expectations of a sharp rise in interest rates of up to 1.75 per cent.
If so, that means Truss and Kwarteng successfully played their 4-D fiscal chess game and got the bank to give them what they want. But before we attribute today’s exchange rate chaos to some Machiavellian currency moves by our new Prime Minister and Chancellor, there are two things that should get us thinking.
First, it’s clear that the pair didn’t expect the mini-budget to go down in the markets as badly as it did. From Sunak’s claims that her ideas would scare moneymen during the leadership campaign to the panglossian future of tax cuts spurring ever-higher growth that Kwarteng laid out on Friday, there was no sign from Truss and Kwarteng that they that saw last 72 hours or so coming.
That wasn’t unreasonable on her part. Markets were keen to lend during Covid and were little intimidated by Johnson’s boosterism. But with the introduction of the biggest string of tax cuts since Anthony Barber, Truss and Kwarteng have shocked markets by being politicians who actually did what they promised during the campaign.
Truss told me two months ago that she sees tax cuts as a way to grow, and she’s implementing them now. The problem for the markets is that it has yet to prove it can deliver two more important things to its agenda. The first is the supply-side reforms, from planning to childcare to energy, that she promised. Will Tory MPs be more willing to pass supply-side reform now than they were two years ago?
The other thing they expect is spending control, and so far there has been no sign of that. Truss was noncommittal when I asked her about an alleged spending review she was considering, and Kwarteng’s statement on Friday didn’t mention any. But there was also no mention of cutting spending in other ways.
Markets therefore assume that Truss is truly nonchalant about borrowing — regardless of the long-term outlook for public finances. Hence the setback. With ministries facing real spending cuts this winter – and wage demands and energy costs soaring – the government needs to have a clear position on spending as soon as possible. Growth is not the answer to every immediate question.
The other reason we may have been wrong in assuming that trussonomics and its authors are interested in higher rates is that their proponents are divided about its necessity. Patrick Minford was quoted in it The times as a suggestion that interest rates should go to 7 percent and that a recession wouldn’t be a bad thing. This is the orthodox monetarist position with which I have some sympathy.
But Minford’s view is not the only one. Our own Gerard Lyons and John Redwood have expressed the view that the inflation we are currently facing is on the way to an end. With energy prices plummeting and the economy adjusting to post-Covid supply shocks, a massive rate hike would be unnecessary now – and against the all-important drive for growth.
When I asked Truss if she thought interest rates were too low, she was unsurprisingly noncommittal. But that didn’t stop them from being shy about changing the bank’s mandate. She may have now backtracked on those comments, and her chancellor may be playing up his friendship with Andrew Bailey. But the criticism genius cannot be refilled.
Truss is not the first Tory prime minister to criticize the bank in recent times. In her first few months in power, Theresa May suggested that interest rates had been too low and savers were losing out. The turmoil this caused soon silenced them, especially as they had more pressing matters to attend to and inflation was negligible.
The decisive factor now will be whether Truss, Kwarteng and Bailey can reconcile. Truss has backtracked on interfering with the bank’s mandate, and we can’t expect her or Kwarteng to say anything publicly that would further spook the market. Hence her silence today. But it is clear that the moneymen have concluded that their policies will not work as intended. Bailey will be guided by them, not her.
It could turn out that inflation falls, growth rises, Bailey doesn’t hike rates according to the direst expectations, and a debt crisis is avoided. In that case, the panic of the past few days will have been an outlier on our happy trek to the sunlit highlands of 2.5 percent growth. This case can be made. Still, today’s headlines aren’t what Truss and Kwarteng would have wanted.
Of course I assume so. And suppose – well, how does the expression go?
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