I had been meaning to write something here for a couple of weeks but… it’s been busy.
Hard to know where to start, really. I’ve reported on a fair few financial crises in my career. Some of them have affected this country. But nothing quite like this: a crisis that was sparked by a Budget.
Now, in practice this story is more complicated than that. There is a lot going on right now: seismic economic swings which have long looked like fuelling disturbances: most notably the reversal of quantitative easing. We have lived, for the past decade and a half, in a world where central banks were pumping cash into our economies. It was an extraordinary period. It is entirely understandable that the end of this period would lead to all sorts of bumps and jolts.
It is hard, at any period in economic history let alone this one, to disentangle individual nations’ stories from the bigger macro and monetary backdrop. Except, what we have witnessed in the UK in the past couple of weeks was also (quite unusually) a domestic crisis.
You have a sense of this when you compare our government bond yields to those in, say, the US and some European countries. Look at how, in the most recent week, the UK bond yield leapfrogged the American one. This was not a global crisis - as various members of the UK government have tried to claim in recent days - but a very specific UK one.
Look at this chart produced by the Bank of England and published in a letter to the Treasury Select Committee this morning.
One key thing to note: how the UK line - the turquoise one - diverges from the Euro and US lines.
Anyway, what kind of a crisis is this? I wrote something about that in a piece for the Sunday Times a few days ago. In broad terms:
Truss’s market contacts are right that there is no straightforward explanation to be found in the fiscal numbers. In practice, it was probably a bit of everything: the scale of the giveaway, the sidelining of the OBR, the firing of experienced Treasury boss Sir Tom Scholar and badmouthing of the Bank of England, the vague promise of more tax cuts over the weekend. Somehow this new government achieved in a few days something that none of its predecessors managed in decades: it inadvertently dismantled the credibility buffer helping to keep the markets aloft.
The symptoms are precisely what you’d expect from a credibility crisis: a falling currency as investors think twice about putting their money into the country, and rising interest rates as they demand more return for holding your (suddenly more risky) assets. Those rates begin to trickle through the economy — into mortgages and business loans — in a perverse reversal of that credibility windfall we enjoyed from 1997 onwards.
The chain reaction of higher rates fans out through asset markets, causing bumps along the way, though quite what those bumps are is hard to predict. At the beginning of last week, few would have anticipated the near-default of swathes of pension assets. But the bigger picture is not just of a vulnerable, brittle financial system but something else: a slow, insidious spiral that eventuates, years later, in a country that is comparatively poorer. A vicious spiral rather than the virtuous circle of growth the “fiscal event” was supposed to create.
Part of the point of the piece was to underline a few things. One is the bit above: this isn’t really about a single measure or even a combination of them but a broader sense of credibility. What, it seemed to me, happened after the mini-Budget was that investors who had hitherto been willing to give the UK the benefit of the doubt started imposing a lack-of-credibility premium on the interest rates they were charging the UK government on its debt - a little as a bank would impose on a dodgy borrower. Economist Dario Perkins is more blunt. He calls it a “moron risk premium”.
Another point worth making: it’s tempting to dismiss these market traders. In much the same way as Boris Johnson once said “f- business”, shouldn’t Liz Truss say “f- markets”? The problem with doing this, however, is that… well you can already see the problem in mortgage markets. When markets decide they want out of a country that has enormous consequences, gradual, some immediate. It pushes up interest rates across the economy (since fewer people want to put money here, we need to offer a higher return to persuade them to leave their money with us) and we’re already seeing what that means. Mortgage rates are whipsawing higher. The fact that the Bank of England still has yet to raise its official rate from 2.25% is beside the point. Markets have already decided that’s where things are heading and since that’s what determines the cost of actual mortgage deals, for the time being that’s that.
Mervyn King had an analogy for this: the “Maradona effect” whereby the Bank could often nudge actual market rates in one direction or the other simply by dropping hints about monetary policy, without actually moving its official rate. The metaphor was based on that astonishing goal in the 1986 World Cup where the Argentinian footballer seemed to dribble round the entire English team before slotting the ball behind Peter Shilton; the point being that actually Maradona had run in a nearly straight line. Well, we seem now to be seeing an alternative version of the “Maradona effect” except this time the Bank of England is not playing the part of Maradona but the English defenders, trying to catch up with the legendary attacker.
The final point of the piece was that Truss’s only real hope of calming markets was some serious u-turns on the mini Budget or the announcement of a quite painful set of spending cuts. I claim no great political insight or foresight, but in the event that’s precisely what happened late on Sunday night as the government decided to scrap the 45p rate abolition. It is also planning to bring forward the Office for Budget Responsibility assessment of the public finances from late next month to late this month.
The idea, as I understand it, is that by signalling how serious it is about the public finances before the next Bank of England meeting and Monetary Policy Report (their quarterly forecasts, scheduled for Nov 3), the Government might allay their concerns about how far they might need to raise interest rates, thus, they hope, ensuring borrowing costs need not rise quite so high.
That - the impact on interest rates - is really the biggest story of all, bigger than what’s happened to the currency, since it has a direct bearing on households pretty much immediately. Indeed, since mortgage lenders base their pricing on the futures curve and since that curve has risen sharply, so too have the cost of two and five year fixed rate mortgages. Here’s a short explainer about that - and the long term consequences:
Anyway, plenty more to come on all this, as you can well imagine. Keep calm and carry on...