Rishi Sunak and Jeremy Hunt were propelled into Downing Street last autumn by a story. The narrative went like this: Conservative Party members had elected Liz Truss as the new prime minister, and she and her chancellor, Kwasi Kwarteng, tried to impose US-style free-market economics on a country struggling to recover from the pandemic. The markets – those unseen gods who must be appeased – recognised Trussonomics for what it was, a badly microwaved bucket of leftovers, and threatened to devour our mortgages and pensions instead. Within weeks Sunak, a former hedge fund manager, was installed as Prime Minister, fiscal responsibility was reimposed and the markets were placated. The numbers returned to normal.
Except they didn’t. The numbers in question are the yields on UK government bonds, or gilts. These yields are similar to interest rates, except they’re decided by people around the world as they buy and sell government debt. They determine not just the cost of government borrowing but the price of debt in the wider economy, including mortgages. They have been rising steadily, and this morning the yield on a two-year gilt rose above the level reached in the chaos after Truss and Kwarteng’s mini-Budget, reaching a 15-year high. Hundreds of mortgage products have already been withdrawn from the market and others are being rapidly repriced at even higher rates than recently expected. Investors would rather lend money to Greece than to Britain.
Surely Hunt and Sunak are the kind of reasonable technocrats the markets favour? Weren’t we led to believe that the adults were back in charge? What’s gone wrong?
Janet Mui, head of market analysis at the investment management company Brewin Dolphin, explains that the Truss story wasn’t untrue: Truss had committed to effectively unlimited borrowing to fund the energy price guarantee, then added £45bn of unfunded tax cuts, so Britain’s cost of borrowing was aggressively repriced. “There was a political risk premium, and an energy price uncertainty premium,” says Mui.
Today, energy prices and politics may be more stable, but the UK has become an outlier in another sense. “It is about inflation,” explains Mui. In sharp contrast to almost every other country, “the UK’s core inflation is accelerating… The government is trying to address that, but for some reason it is still out of their control.”
The Bank of England attempts to control inflation using its base rate of interest, which it has hiked twelve times in a row, to 4.5 per cent – and Mui says markets are now pricing in a peak of 5.75 per cent. This expectation is enough to cause yields to rise (higher Bank rates mean higher gilt yields), but it’s compounded by the fact that in the US and Europe, inflation seems to have turned the corner, which means their rates may soon plateau or fall.
Have the central banks of Europe and the US done more to fight inflation, then? No. In fact, the Bank of England was the first major central bank to hike, and the UK’s bank rate is higher than Europe’s. If there hasn’t been a major difference in monetary policy (decisions made by the Bank of England), then the UK’s precarious position must be the result of economic policy (decisions made by the government).
This seems to be the case with the rise in gilt yields today, which followed the announcement of employment figures showing a further tightening of the UK’s labour market. Part of the reason that there are fewer people are available for each job vacancy is that a record 2.5 million people are economically inactive due to long-term ill-health, which is the result of policy choices around the funding of public services, particularly social care. We also lost a third of a million workers to Brexit. British people are more car-dependent than other Europeans, and therefore more exposed to the cost of fuel, because we have the continent’s most expensive public transport. British homeowners are exposed to fuel prices by our old and poorly insulated housing stock. All of these inflationary pressures are the result of decisions taken by successive prime ministers – all of whom, for the last 13 years, have been from the Conservative Party.
The UK also appears to lack a plan beyond hoping inflation will fall so that the Conservative Party can take the credit. While the US and Europe are investing huge sums in green energy as part of long-term plans to combat inflation, we’re pitching to host some sort of AI event, perhaps in the hope that a sentient computer will come up with a solution.
The truth is that the political premium charged by financial markets – known as the “moron premium” when it was Liz Truss’s fault – has been building for some time, in response to our ever more unequal and precarious economy. It now belongs to Rishi Sunak.
[See also: Will Rishi Sunak sack Jeremy Hunt?]