Sunday, October 30, 2022
Steady on Rishi, don't overdo the gloom
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission.

Five days on I am still digesting Rishi Sunak’s opening comments when he took over as prime minister on Tuesday. To remind you, he said that the UK is facing a “profound economic crisis”, some of it due to the mistakes made by his short-lived predecessor, which he would seek to fix. Normally you expect to hear this kind of thing when a new government has taken over from another party and cannot believe the state they have left things in.

When James Callaghan entered 11 Downing Street as Labour chancellor in 1964, he found a note in the office from his Tory predecessor Reginal Maudling, saying: “Good luck, old cock …. Sorry to leave things in such a mess.” History repeated itself in 2010, though the other way round, with the infamous “I am afraid there is no money” note from the outgoing Labour Treasury chief secretary Liam Byrne, which he later greatly regretted.

This time of course the wrecking ball was provided by somebody who, until very recently, Sunak sat around the cabinet table with. I took part in a quiz recently in which one of the questions was to name the four most recent chancellors. I obsess about these things and got it right but ask me again in a few years’ time and the names of Nadhim Zahawi and Kwasi Kwarteng may struggle to come to mind. We will wonder whether the Kwarteng chancellorship, like the Truss premiership, was something we imagined, like the dream sequence in Dallas which saw Bobby Ewing eventually restored to life.

Anyway, it really did happen, and created a significant part of Sunak’s profound economic crisis. Incidentally, when people like me talk of economic crisis, profound or not, we are sometimes accused of talking the economy into recession, a particular danger when consumer and business confidence are so weak. It is apparently OK for prime ministers to say so but, and here is the interesting thing, while markets are waiting for the government’s delayed fiscal plan on November 17, one element of the crisis looks to be over.

Sterling is up by roughly 10 per cent from its all-time lows in the wake of the September 23 maxi-mini budget, while the yields on UK government debt, gilts, have come down markedly. The 10-year gilt yield is down by nearly a percentage point to 3.6 per cent at time of writing, while the 30-year yield is no longer 5 per cent but more reassuring 3.7 per cent. The dream sequence has not yet started but it is almost as if September 23 had never happened.

Sunak and Jeremy Hunt, the chancellor, still have some tough decisions to make between now and November 17 but the drop in gilt yields has made their task easier. No longer will the Office for Budget Responsibility (OBR) be basing its debt interest projections on these very high interest rates. The black hole in the public finances, already made greyer by Hunt’s reversal of most of the Truss tax cuts, is not yet closed, but is paler still.

Lower gilt yields, and market rates in general, also mean that mortgage rates, which have already eased back to an extent, should do so further. No longer is the housing market facing fixed rate mortgages of 6.5 per cent plus, with lenders now offering lower rates in response to calmer markets. The job of fixing the public finances is not done but markets have confidence that it will be, which they did not have until the change of chancellor and prime minister.

There is still the small matter of what the Bank of England does on Thursday. The City expects it will follow the European Central Bank (ECB), which raised interest rates by three-quarters of a point, 75 basis points, on Thursday, although some think the Bank will opt for a more modest 50, as with its last two hikes. A 75 basis point increase, taking Bank Rate to 3 per cent, would represent the biggest sustained rise since October 1989. Incidentally, the increases on “Black Wednesday”, September 16 1992, do not count on the record because they were immediately cancelled when unsuccessful in propping up the pound.

The new economic forecasts we will get from the Bank on Thursday need to be looked at in the context of how profound this economic crisis is. According to independent economic forecasts compiled by the Treasury this month, the average new forecast is for a 0.3 per cent drop in gross domestic product next year, in other words a mild recession.

It is quite possible that the Bank will be gloomier than this, as it was in August, its last forecast, but this should be seen as part of its messaging. Its August forecast was based on no further help from the government with energy bills and this week’s forecast, by convention, will be based on market expectations for Bank Rate, which are for a rise to around 5 per cent. A very gloomy growth forecast from the Bank should be seen as a signal that it does not think official interest rates should rise as much as this.

The Bank has a trickier task in forecasting inflation because, as part of the Hunt-Sunak fiscal repair job, the two-year freeze on domestic energy bills, the energy price guarantee, is now only for six months, with a more targeted policy to come into force in April. That will keep measured inflation a bit higher but, given that the Bank thought the freeze would add to, not reduce, underlying inflationary pressures, not raise the medium-term forecast. In August the Bank thought a 3 per cent Bank Rate peak would deliver 2 per cent inflation in two years and less than 1 per cent in three. This week it should say that a lower Bank Rate peak than 5 per cent – I would say 4 – will do the same now.

None of this should disguise the fact that pain is on the way. The cost-of-living squeeze is real and most intense for those on the lowest incomes. For the November 17 fiscal statement, Sunak has to consider whether to reinstate more tax increases – he was very fond of the health and social care levy that had its roots in the now cancelled national insurance hike – alongside spending cuts. There will be unpopular decisions in pursuit of the stability he considers essential for sustained economic growth.

You can call all these things a profound economic crisis but there is a bigger underlying problem, as identified by Sunak when he was chancellor, notably in his Mais lecture at London’s City University in February. The UK’s productivity stagnation is partly explained by low business investment – 10 per cent of GDP in the UK compared with an average of 14 per cent in competitor countries – and insufficient spending on skills on training. UK businesses spend half of the amount their European competitors do on skills’ training.

These were some of the problems Sunak pledged to fix when chancellor, starting with measures this autumn to incentivise business investment despite the coming rise in corporation tax. They should not be forgotten now. Dealing with immediate difficulties is understandably the priority now but there are longer-term problems too, exacerbated by Brexit and the pandemic. A failure to have some kind of plan to tackle them will leave us with a recurring productivity and growth crisis.