Jeremy Hunt went to parliament on Monday to bury Trussonomics, not to praise it.
In a knifing fit for Shakespeare’s Julius Caesar, the chancellor vanquished the rightwing “mini” Budget that Liz Truss had used to put forward £45bn of unfunded tax cuts.
Hunt reversed most of the prime minister’s tax cuts that were meant to boost UK economic growth. He also signalled plans for tax increases and public spending cuts in his fiscal statement due on October 31 as he sought to reassure financial markets that the government was serious about balancing the books and cutting debt.
Hunt curtailed Truss’s scheme to cap all British households’ annual energy bills at £2,500 on average for two years, saying it would end after just six months. And he unveiled a new economic advisory council, packed with people steeped in Treasury orthodoxy.
A recently-departed senior Treasury official said: “Liz Truss picked a fight with economic orthodoxy and the orthodoxy won.”
Treasury insiders privately agreed Trussonomics had been ditched as Hunt sought to end the market turmoil that followed the mini Budget unveiled on September 23 by the then chancellor Kwasi Kwarteng.
The acute situation was underlined when the Bank of England on September 28 launched an emergency government bond-buying programme to protect parts of the pension industry threatened by insolvency after gilt yields spiked sharply.
Hunt hopes to minimise the damage, limiting the depth of the coming recession and bringing UK government borrowing costs back into line with where they were before Kwarteng’s fiscal statement.
There was no single moment when Treasury officials managed to persuade Truss’s government it was steering the UK economy towards the rocks.
Officials had noted with alarm rising global interest rates in response to surging inflation over the summer, following the Covid-19 pandemic and Russia’s invasion of Ukraine.
On top of this a damaging premium was being added by investors to UK government borrowing costs, resulting from perceptions of fiscal recklessness under Truss. This premium has been dubbed the “moron premium” in the markets.
Together, these global and domestic issues meant that when Truss became prime minister on September 6, the £30bn of headroom for potential tax cuts or spending increases that existed at the time of the March Budget against the UK’s fiscal rules had been transformed into a gaping hole in the public finances.
But instead of tightening the government’s belt, Truss and Kwarteng added £45bn of additional borrowing for their tax cuts.
The Institute for Fiscal Studies think-tank last week estimated the fiscal hole at £60bn, but as markets roiled and government borrowing costs rose, it increased to close to £70bn.
Treasury officials produce daily estimates of the likely forecasts for UK economic growth and the public finances coming from the Office for Budget Responsibility, based on the latest pricing in the markets — and the figures looked increasingly dire as the “moron premium” rose. The UK fiscal watchdog will publish its new set of forecasts on October 31.
The action Hunt is taking is designed to tighten fiscal policy after Truss’s inflationary mini-Budget. It should allow the Bank of England’s to pull back from extreme interest rate rises, and also bring down the cost of government borrowing so that fewer tax increases and spending cuts are needed to balance the government’s books.
With a £70bn fiscal hole, Hunt filled £32bn of it by scrapping Truss’s tax cuts, but that still left a shortfall of roughly £38bn, and that is why he stressed orthodoxy and further measures to come.
Each 1 percentage point fall in short-term and long-term government borrowing costs cuts the expense of servicing the debt by between £15bn and £20bn a year.
And while the total interest bill on the debt in the medium term has risen from a forecast of about £50bn a year in the March Budget to almost double that in internal Treasury estimates, a significant amount could be saved by restoring some market trust in the government.
On Monday afternoon, Hunt’s moves appeared to be working. The markets expected the BoE bank rate in August 2023 to be 5.1 per cent, down from 5.6 per cent last week, a 0.5 percentage point drop. Similar falls in long-dated gilt yields suggested about £10bn of the fiscal hole could be filled from lower borrowing costs.
That left about £28bn to find, partly through spending cuts. These are likely to be spread across day-to-day spending on public services, investment and non-pensioner welfare benefits. There are few indications of how much Hunt wants to raise through tax increases.
Meanwhile Hunt unveiled an advisory council made up of economists with close ties or former links to the Treasury: Rupert Harrison, who was as an adviser to former chancellor George Osborne; Karen Ward, who worked for ex-chancellor Philip Hammond; and two former members of the BoE Monetary Policy Committee, Sushil Wadhwani and Gertjan Vlieghe.
Paul Dales, at the consultancy Capital Economics, said Trussonomics had been “killed off” even more thoroughly than expected with Hunt’s decision to review the scope of Truss’s energy price guarantee for households, adding that the policy shift, by lowering government bond yields, would help fill the fiscal hole.
But he said even without the UK’s self-inflicted fiscal drama, the global context and tight British labour market would still have led to higher gilt yields and put pressure on interest rates.
However David Page, economist at Axa Investment Managers, said the fact that yields remained relatively high reflected “the erosion of the government’s fiscal credibility — something that is quicker to lose than to gain”.
Kallum Pickering, economist at Berenberg Bank, said the government might now be forced to “overcompensate on fiscal discipline to shore up its credibility”.
He added that the risk of very sharp increases in interest rates had receded only because the government was now having to be very aggressive on fiscal policy — and the result for the economy could be the same, a sharp recession because “they have to over do it”.
Pickering said austerity was the result of the UK’s short experiment with Trussonomics.
