Last week it was the U.K. government that blinked, not the Bank of England, in the face of vengeful financial markets.
But until UK Prime Minister Liz Truss goes, there will be no stability for gilts or sterling. Both may stabilise in the near term, following last week’s U-turn on economic policy and the change of Chancellors. But the trend for both must surely be downwards as long as Truss remains in power, her allies feel free to offer ‘advice’ to the Treasury, and ‘higher for longer’ interest rates suppress growth.
Truss may be neutered, but the idealogues who backed her aren’t
The new UK Chancellor of the Exchequer, Jeremy Hunt, is likely to have more authority in the ruling Conservative Party than Prime Minister Liz Truss. Economic policy will be in his hands alone since Conservative MPs will support him over Truss and the think tanks that cooked up ‘Trussonomics’ as they try to claw back a reputation for economic competency and save their jobs at the next election.
A Prime Minister without influence on economic policy or public spending is essentially neutered, with little ability to drive forward any policy that requires a financial commitment without her Chancellor’s permission. It is humiliating, but in this instance, it may not be enough for the gilt market -and by extension, sterling.
It is not just that they fear Truss’ recklessness as an individual. It is that she is totemic of a casualness about the reality that has engulfed the Tory party since the 2016 Brexit debate.
The drunken captain may now be locked away in the storeroom, but it is not only the captain who has been drinking.
Almost without exception, it is the same economists, politicians and think tanks that pushed the Conservative Party into being the standard bearer for Brexit after the referendum, that backed Boris Johnson in his revolt against Theresa May’s premiership, and who supported Liz Truss in the recent leadership campaign.
Many have been apologists for Truss and former Chancellor Kwasi Kwarteng’s policy of borrowing to pay for tax cuts, justified because the U.K. hasn’t borrowed as much as many other countries (as measured by debt to GDP ratios). This implied that some kind of credit facility is in place with the gilt market, which proved a disastrous calculation a month ago when the mini-budget was announced.
The ability of these people to undermine Hunt’s authority should not be underestimated, given their ties with right-wing newspapers, their willingness to change the facts to suit the ideology, and their proven recklessness.
‘Traitor to Brexit’ and ‘Traitor to Conservative values’ will be some of the newspaper headlines that Hunt will no doubt have to face from The Daily Mail and his party colleagues if he is going to ease relations with the EU, to support growth, and raise taxes in April as his immediate predecessor, Rishi Sunak, had planned.
These were, after all, the same people and media organisations that assured voters in 2016 that a Brexit trade deal with the EU would be easy to achieve and that large economies would ‘come rushing’ to sign trade deals with the UK.
They have no answer to the Office of Budget Responsibility’s (still standing) claim from 2020 that the hard Brexit the UK chose will reduce potential GDP growth by 4% over the next fifteen years, other than saying that ‘experts often get it wrong’. Which is, of course, true. But their answer reveals they have no better forecasts.
Liz Truss’ allies will get a sympathetic hearing from the Conservative Party members, who chose Truss as the party leader. They have effectively been snubbed by the party’s MPs, who preferred Rishi Sunak and resent the humiliation of seeing their choice being so publicly humiliated. And, of course, they have the right to choose her successor.
The outlook for gilts and sterling
Until the Conservative Party ditches its aggressive approach to Brexit-related policy, and the people behind it, the party will not be trusted with the economy. Fiscal austerity from the new Chancellor will be needed to appease investors.
Add to this the Bank of England’s clear determination to not only end its emergency gilt buying program but to shrink its balance sheet by selling bonds it has bought over the last decade (quantitative tightening, or QT), and we can see tight fiscal and monetary conditions shrinking GDP growth estimates.
It is, therefore, possible to imagine austerity driving down growth. At the same time, gilt yields rise because of oversupply (coming from the budget deficit and QT), and sterling falls as overseas holders of gilts renew their selling.
The week ahead
The coming week sees little significant economic data on either side of the Atlantic besides the UK September CPI inflation data on Wednesday. Consensus is for a 10% year-on-year number (up a notch from 9.9% in August), while the month-on-month figure is expected to be down at 0.4% (from last month’s 5%).
Any sharp deviations from the consensus estimates will probably elicit a response from the Bank of England, given the current nervousness of the markets.
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