For those of us who habitually pronounce on Trussonomics, the assumption has long been that Truss and Kwarteng are keen on higher interest rates. As Kate Andrews put it in a Tweet this morning, the Truss government “wants…rates to rise faster” as it is a “key part of its new economic strategy”. Monetary tightening to counteract fiscal loosening.
So, in that case, the frantic market reaction to the mini-Budget – if it forces the Bank of England to raise rates faster than it has done so far – is a blessing in disguise. Whilst most of today’s coverage has focused on the pound yo-yoing to and then up from a record low, the surging cost of gilts and the growing expectations of a sharp rate rise of up to 1.75 per cent are the bigger story today.
If so, that would mean Truss and Kwarteng have successfully played their game of fiscal 4-D chess and bounced the Bank into giving them what they want. But before we attribute today’s exchange rate mayhem to some Machiavellian monetary moves on the part of our new Prime Minister and Chancellor, there are two things that should give us pause for thought.
First, it is clear that the pair did not expect the mini-Budget to go down as badly with the markets as it has done. From poo-pooing Sunak’s claims that her ideas would spook the money men 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 saw the last 72 hours or so coming.
That wasn’t unreasonable on their parts. The markets were very happy to lend during Covid, and they were hardly spooked by Johnsonian boosterism. But by launching the biggest set of tax cuts since Anthony Barber, Truss and Kwarteng have shocked the markets by being politicians who actually are doing what they said they would whilst campaigning.
Truss told me two months ago that she saw tax cuts as the route to growth, and she is now delivering them. The problem for the markets is that is yet to prove she can deliver two other things crucial to her agenda. The first is those supply-side reforms, covering planning to childcare to energy, she has promised. Will Tory MPs be more willing to pass supply-side reform now than they were two years ago?
The other thing they expect to see is spending control, and of that there has so far been no sign. Truss was non-committal when I asked her about a supposed spending review she was contemplating, and Kwarteng’s statement on Friday made no mention of one. But it also made no mention of cutting spending in any other way.
The markets are therefore assuming that Truss really is nonchalant about borrowing – whatever the long-term outlook for the public finances. Hence the backlash. As departments face real-term spending cuts this winter – and as wage demands and energy costs soar – the Government needs to have a clear position on spending as soon as possible. Growth isn’t the answer to every immediate question.
The other reason why we may have been wrong to assume that Trussonomics and its authors are keen on higher rates is that its exponents are divided on their necessity. Patrick Minford was quoted in The Times as suggesting rates should rise to 7 per cent, and that a recession would be no bad thing. That is the orthodox monetarist position, and one with which I have some sympathy.
But Minford’s is not the only view. Our own Gerard Lyons and John Redwood have aired the view that the inflation we are currently facing is on its way out. With energy prices plummeting and the economy adapting to post-Covid supply shocks, a massive hike in interest rates now would be unnecessary – and against the all-important pursuit of growth.
When I asked Truss whether she thought interest rates had been too low, she was, unsurprisingly, non-committal. But that did not stop her from not being shy on the need for the Bank’s mandate to change. She may have rowed back on those comments now, and her Chancellor may be playing up his amity with Andrew Bailey. But the criticism-genie cannot be rebottled.
Truss is not the first recent Tory Prime Minister to criticise the Bank. In her first few months in power, Theresa May suggested rates had been too low, and savers had lost out. The uproar this triggered soon caused her to keep quiet, especially as she had rather more pressing matters to attend with, and inflation was negligible.
The crucial thing now will be to see if Truss, Kwarteng, and Bailey can make up. Truss has rowed back on interfering with the Bank’s mandate, and we cannot expect her or Kwarteng to say anything in public that would spook the market further. Hence their silence today. But it is clear the money men have concluded that her policies will not work as intended. Bailey will take his lead from them, not her.
It may play out that inflation falls, growth rises, Bailey does not hike rates in line with the gloomiest expectations, and a debt crisis is avoided. In that case, the panic of the last few days will have been a blip on our merry path towards the sunlit uplands of 2.5 per cent growth. That case can be made. Nevertheless, today’s headlines are not those Truss and Kwarteng will have wanted.
I’m assuming that, of course. And assuming – now, how does the expression go?