Before the mini-Budget, I wrote that Kwasi Kwarteng’s first act as Chancellor should be to sack Andrew Bailey as Governor of the Bank of England. Regular readers of my economic missives will know that I think Bailey is a dud.
He failed to see inflation coming. Then he claimed it would be transitory. He has been consistently playing catch-up when it comes to raising interest rates, and his communication has been woeful (remember “Armageddon”?) The farcical mixed messaging from the Bank yesterday morning – with Bailey saying there would be no further interventions after Friday, and Bank sources then leaking that the opposite had been told to bankers and pension funds in private – was eye-raising.
Bailey remains in place for three reasons. Firstly, since Gordon Brown made the Bank of England functionally independent in 1997, it has become an unwritten rule that politicians cannot criticise Threadneedle Street or opine on monetary policy. When Theresa May did so, she was swiftly made to row back on her comments.
Secondly, because Liz Truss and Kwarteng have realised they need the Bank on side. During her leadership campaign – and her interview with me – Truss suggested obliquely she wanted to reform the Bank. This provoked opposition. It became clear to Truss that she couldn’t hope to do tax cuts, supply-side reform, and fiddle with the Bank at once. Kwarteng and Bailey have thus been buddying up.
Thirdly – and most importantly – it is because the Prime Minister and her Chancellor have done a stellar job of directing all the blame for this mess onto themselves. Ever since the mini-Budget spooked the markets by producing a £60 billion hole in the public finances, the pair’s successive blunders have soaked up any bad press that Bailey should be getting, and made us the target of international criticism.
Still, the Governor’s decision to inform a DC audience on Tuesday that the Bank’s guilt-buying programme would not be extended past Friday has shot him back into the spotlight. His bluntness has virtues. By telling pension funds they must sort their acts outs, that these interventions cannot be routine, and that his job is not simply bailing out governmental incompetence, he is giving a kick up the arse to a sector that was sailing close to the regulatory wind, and defending his independence.
Even so, this posturing was quickly rendered absurd by reports that the Bank was privately telling relevant parties that some form of aid would continue. Threadneedle Street looked incoherent, and Bailey looked inept. This is especially as – with yields still turbulent – something will have to be done. Who was the Governor trying to fool?
Briefly, the background. Essentially, some pension funds invested in the Liability-driven investing (LDI) market after 2008, because the record low interest rates and unprecedented bond-purchasing that formed the core of our response rendered other investment routes less attractive. These investments were vulnerable to sudden, big rises in gilt yields. Two weeks ago, the Bank announced – alongside an interest rate rise – it would begin quantitative tightening. Selling off bonds, as well as raising interest rates, to you and me.
Unfortunately – in what amounted to the worst bit of timing since JFK fancied stretching his neck to get a better view of a grassy knoll – the very day after this announcement, the new Chancellor designed to drop into this febrile market the biggest package of tax cuts in fifty years. More importantly, he chose to do so without saying what spending would be cut to pay for it, and without laying out a plan to reach the 2.5 per cent growth that he claimed would make the package viable.
So the markets went haywire, gilt yields surged, and those pension funds who had stress-tested for a small and gradual rise in yields found themselves up something-creek, without a paddle.
Consequently, the Bank made its emergency intervention, and pledged £65 billion to buy bonds and reduce yields. This calmed the markets. Nonetheless, there has been little actual interest by the funds in buying the bonds. This suggests they are selling other assets to stabilise their portfolios. It also suggests that they fear the increase in money supply that purchasing the bonds would constitute. It would be inflationary – and they are losing confidence in Bailey’s Bank to keep inflation under control.
Hence why borrowing costs are still rising. Hence why markets are assuming Bailey will have to do more. Hence why they are increasingly expecting a huge U-turn from the Chancellor. Information takes time to sink in, since not all bankers read ConHome. Only on Monday did they fully clock that the intervention would be running out this Friday. With that in mind, if they are currently expecting massive spending cuts on Halloween, how how will they react when they get the implications of Truss’s claim yesterday that spending won’t be cut?
Of course, she might mean that she does not plan to increase departmental budgets in line with inflation. This would mean swinging real-terms cuts across the board. It would trigger as massive battle with the public sector unions over wage restraint – predicted by moi several months ago – and would be hugely unpopular with already-jumpy MPs. So what Kwarteng plans to announce on the 31st is a mystery. I expect he doesn’t entirely know.
Plainly, once the money men realise this, whatever confidence they have left in Kwarteng will further plummet. They will conclude he cannot do his basic job: paying the nation’s bills. Still, Bailey’s recent performance has been equally lacklustre. He has consistently underperformed market expectations, and been wrong at every turn. If Kwarteng isn’t doing his job properly, than neither is Bailey. He has not kept inflation under control. Which leaves us in remarkable territory.
I cannot think of a time when the markets did not have confidence in either the Chancellor or the Governor of the Bank of England. As our Editor has explained, if confidence in Kwarteng is gone, the logical result is his resignation, the mini-Budget’s junking, and Truss fretting she won’t beat George Canning’s record for time in Downing Street. The equivalent for Bailey would be that he either resigns or that he is sacked. The former, to avoid setting a precedent, might be preferable.
Who could replace him? Reviewing the alternatives from Bailey’s appointment three years ago, and considering what has happened subsequently, I would suggest they must fulfil three major criteria. They must have the confidence of the markets, which suggests a reliable suit from either a financial institution or a major Bank. But if that means another Bailey, no thanks.
So they must also have seen inflation coming – like Andy Haldane, the Bank’s former chief economist. And they must also understand the Bank has a communications problem. Before Bailey’s appointment, Helena Morrissey, the noted financier, was a contender, and criticised the Bank for failing to engage with markets or the country. Neither of those are recommendations, but examples of the qualities that the next Governor should possess.
There is, however, one person I can think of who would go a long way to ticking all those boxes. They are also a talented communicator, and saw the mess of the last few weeks coming. Even better, they are recently unemployed. I’m sure they would be more than happy to work with Truss to restore some form of economic stability. They would certainly inspire more confidence from the markets than the incumbent.
So, does anybody know what Rishi Sunak is doing nowadays?