On Friday, the pound fell -3.4% to £1.086, its lowest level against the dollar in over 30 years, while the cost to the UK government to borrow money over 5 years jumped by 0.50%, its largest daily rise ever. This sell-off in response to Kwasi Kwarteng’s budget built on weeks of selling in UK assets on the back of fears that something really stupid was coming down the tracks (I discussed the “human hand grenade” risk back in late July).
In the few short weeks since Liz Truss became the odds-on favourite to win the Tory leadership race, UK borrowing costs have more than doubled, a remarkable development considering the surge in rates in the prior 9 months.
The sell-off in rates and the pound reflects a loss of faith in the prudent management of the UK’s finances. This process began many weeks ago in response to the incoming government’s comments, and has accelerated since their words began to translate into actions. There are two factors contributing to this dynamic:
- Inflationary fears: Lower taxes will put more money in people’s pockets which will lead to increased demand and, in turn, push inflation higher. The same applies to any further stimulus they have up their sleeve to drive growth while the Bank of England battles to bring inflation under control.
- Loss of credibility: The government has demonstrated that it doesn’t care about managing the public debt responsibly and is willing to stake the whole country’s future on black (but with much worse odds than at a roulette table).
There’s a school of thought among investors and economists that Kwarteng’s budget is not actually inflationary because the benefits are so skewed to the very wealthiest that they are unlikely to translate into incremental demand. In other words, someone earning £200k is unlikely to spend more because their tax bill has dropped by £5k — they are going to save and invest that money.
According to this interpretation, the market is selling off for the second reason only, because Truss and Kwarteng have shown that they are not serious people fit to run a country. To quote one economist at macro consultancy TS Lombard:
“The problem isn’t that the UK budget was inflationary, its [sic] that it was moronic. And a small open economy that seems to be run by morons gets a wider risk premium on its assets — currency down, yields up”.
Nobel prize winning economist Paul Krugman concurred that the budget was “stupid and cruel”, but sounded a hopeful note in saying:
“[A]t a guess, the moron risk premium has now been priced in. I guess I don’t see the mechanism for a continuing sterling crisis.”
The judgments of intellectual horsepower (and even sanity) are by no means confined to any ideological quarter. To quote a Tory MP this weekend:
“This whole thing boils down to infectious childlike optimism in Downing Street. It would almost be endearing if it wasn’t so completely and utterly fucking mad”.
And a former Tory minister added that “anyone who isn’t mad hates it.”
So, the judgment passed by markets and by commentators is consistent: an ideologically neutral assessment is that we are being governed by idiots. Idiots are unpredictable and so the market increases the risk premium on UK assets to account for future stupid decisions they may make.
But Krugman’s view that this may now be priced in feels optimistic. The arrogance that so often accompanies great stupidity would suggest that the government is more likely now to double down than to retreat. The Financial Times quotes them openly talking about a “go big or go home” strategy, an open admission they are willing to take the country down with them in their quest to retain power.
