Sunday, December 25, 2022
Those who live by the markets can be undone by them
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.

This is my last column of 2022, and this is not a normal Sunday, but I cannot let it go without reflecting on something than happened three months ago, before the memory begins to fade and it takes its place in history.

Just over three months ago, on about September 20, I was a long way from London – I won’t say where – when news reached me about Kwasi Kwarteng’s forthcoming mini budget on September 23, a rare important Friday economic statement; normally a very quiet day in Westminster.

Had that news reached me a few days earlier. I would have shared it with you, but it was too late for a Sunday journalist, or for that matter for my midweek column for The Times.

The news, of course, was that the then chancellor intended to throw the kitchen sink into his mini budget, not just reversing the increases in national insurance and corporation tax but bringing forward a penny off the basic rate of income tax, abolishing the 45 per cent additional rate of income tax – then the rate on incomes above £150,000 (now just over £125,000) – as well as scrapping the cap on bankers’ bonuses.

The odd thing about this, and its most eye-catching element, getting rid of the 45 per cent rate, was that it was immediately clear to me, and to my informant, that this would go down like a lead balloon with voters and the financial markets.

Those who cheered it to the rafters, and quite a few did, did not understand markets, nor voters. Neither did the then prime minister, Liz Truss, nor her first chancellor, Kwarteng. I assume it may have been their naïve belief that a mini budget which abolished the cap on bankers’ bonuses and the 45 per cent rate would have gone down a storm in the City, an echo of Nigel Lawson’s historic 1988 budget. But there is a big difference between what is good for well-rewarded individuals and how they will respond as market players. Many of the hedge fund grandees who were significant personal gainers from the proposals profited by shorting the pound. As it is, the consequence of all this is that the 45 per cent rate now kicks in at a lower level of income than before, it abolition having been scrapped, and more. Quite funny really.

The Truss-Kwarteng period, brief though it was, was damaging. The former chancellor is gone, but so is the well-respected former top civil servant at the Treasury, Sir Tom Scholar, who Kwarteng sacked on arriving in the department. He, I think, would have advised against the mini budget but his sacking discouraged others in the Treasury from speaking out. You might have thought that Scholar could have been reinstated when Kwarteng went, but apparently that does not happen. Politicians come and go but professional civil servants, once sacked, stay sacked.

The reason that the Truss-Kwarteng episode also stood out was that it was the first time I can think of that a UK prime minister and chancellor have been brought down by the reaction of the financial markets. A badly received budget in the markets used to be the FTSE-100 falling by 40 or 50 points and sterling dropping a cent against the dollar. People used to say that a budget which went down badly on the day would look good six months later. The reaction to this one was thus off the scale and that rule would not have applied.

The mini budget, and some unwise comments from the then chancellor about even more tax cuts on the near horizon, not only sent the pound crashing to a record low but also, for a time, provoked the biggest crisis in the gilt (UK government bond) market in decades, perhaps ever.

The Bank of England, which was required to intervene in the gilt market in financial stability grounds, to prevent a so-called doom loop in which pension funds needing to meet their short-term obligations were forced sellers of gilts, should perhaps have been more aware of the risks. But it had no idea that the then prime minister and chancellor would do anything quite so stupid and was forced to mop up.

It is hard to argue, on this occasion, that what the markets did was wrong. Governments should not get away with a ridiculously cavalier approach, or with undermining the UK’s institutions, including the Bank and Office for Budget Responsibility (OBR). Truss and Kwarteng deserved what they got, though we as voters did not deserve them.

Kwarteng has since said, in effect, she made me do it, though I do not think he will ever lose his reputation as the chancellor who crashed the markets. Truss, by all accounts, is unrepentant. She promised to hit the ground, which she did, but appears to think that only by trying to do too much at too quickly did she fail to hit the ground running.

We can debate what might have happened had the contents of the mini budget been limited to merely reversing the hikes in national insurance and corporation tax, as Truss promised during the Tory leadership contest. They were anticipated and thus “in the market” so there would have been no logical reason for the kind of reaction that we saw, Who knows? Perhaps Truss would still be prime minister and Kwarteng chancellor, though as a team they were an accident waiting to happen.

Even though the result was the right one in this case, should we be at all troubled by the fact that the markets brought down a prime minister and chancellor? The public finances remain vulnerable, as demonstrated by a record for the month of £22 billion of public sector net borrowing announced a few days ago.

This was supposed to be a time of repair for the public finances but, while we should not see a budget deficit of £313 billion for some time – this was the 2020-21 figure, swelled by the pandemic – this year’s borrowing is set to come in more than £50 billion above the £126 billion of 2021-22. Borrowing is being swelled by the cost of energy price support and a rising debt interest bill, now running at more than £100 billion a year.

If the public finances are still shaky, how concerned should we be, that history will repeat itself? Imagine a situation in which the government decides to risk an increase in the budget deficit, not via unfunded tax cuts but say by a bigger increase in nurses’ pay, which the government is so far resisting but for which there would be very strong public support.

I don’t think it would happen, because such a move would cost only a fraction of the September 23 tax cuts and would increase rather than reduce public support for the government (though it would be a U-turn), but it is a concern. Once the markets have demonstrated their power over elected politicians there is no guarantee that they will not be back for more.

Rishi Sunak and Jeremy Hunt, by adopting an ultra-conservative approach to the public finances, are hoping that they will not. Let us hope so, anyway. Late September and early October was a scary, if fascinating, time.