How the markets broke ‘Trussonomics’

The announcement of former UK prime minister Liz Truss’s “mini” Budget after almost three weeks in office marked the end of her political honeymoon.

The collapse of Truss’s economic project, dubbed “Trussonomics”, would seal her fate and deal a lasting blow to the Conservative party’s reputation for fiscal responsibility. Her ideological “mini” Budget contained £45bn of unfunded tax cuts — the biggest tax cuts for 50 years.

The response from the markets was swift. The value of sterling plunged while government borrowing costs spiked, which threatened the solvency of parts of the pension industry. The Bank of England launched an emergency government bond-buying programme in an attempt to stabilise markets.

In the weeks that followed, Truss would sack her chancellor and reverse most of her proposed tax cuts. These extraordinary events culminated in her departure from office after only 44 days — the shortest premiership in British history.

The background

Traders at the New York Mercantile Exchange — © Seth Wenig/AP

The UK economic programme that became known as “Trussonomics” had its roots in persistent real-world economic problems and the ideological tenets of a wing of the Conservative party.

Line chart showing Trussonomics was an attempt to shock the UK economy of out low growth

UK economic growth had not recovered after the global financial crisis of 2007-09, leaving productivity flat and real incomes stagnant in the years that followed.

In the 2012 book Britannia Unchained, the rising stars of a new generation of Tory MPs — including Liz Truss and Kwasi Kwarteng — called for a return to the free-market Thatcherite principles of low tax and supply-side reforms.

Boosting growth was key to their credo, which said the UK should stop indulging in “irrelevant debates about sharing the pie between manufacturing and services, the north and the south, women and men”. Tax cuts would pay for themselves if they enabled the economy to grow.

Chart showing in 2022 a long period of low inflation and interest rates ended

By July 2022, when Boris Johnson resigned as prime minister, the resulting Conservative party leadership campaign was fought against the backdrop of a full-blown cost of living crisis, with inflation at a 40-year high and interest rates rising in response.

Rishi Sunak and Liz Truss — © Hollie Adams/Bloomberg

Truss won the leadership race on the Britannia Unchained manifesto. Her main rival, former chancellor Rishi Sunak, argued that her plans for radical tax cuts were unworkable.

Kwasi Kwarteng and Liz Truss — © Shutterstock

After assuming office on September 6, Truss appointed Kwarteng as chancellor and sacked the top civil servant at the Treasury, Tom Scholar. During her campaign, Truss had referred to a “Treasury orthodoxy” that was holding back growth.

Kwarteng announced an energy support package to cap the unit price of energy and protect households and businesses from soaring bills. He also announced an emergency fiscal statement (later styled by the Financial Times as a “mini” Budget) on September 23.

Image showing header of Martin Wolf column

Ahead of the statement, the FT’s chief economics commentator Martin Wolf pointed out that Margaret Thatcher’s government had already cut top tax rates and deregulated the economy . . .

Chart showing real business investment peaked at the time of the Brexit referendum

. . . and that the UK’s record on investment was poor, particularly since the Brexit vote in 2016. “What is simple has already been done. What is left is hard to do,” he wrote.

Chart showing no clear correlation exists between tax and prosperity in big high-income countries

There was also no obvious relationship between the tax burden and prosperity.

The “mini” Budget and aftermath

Crucially, Kwarteng decided to dispense with the independent forecasts from the Office for Budget Responsibility that are customary ahead of fiscal statements.

Chart showing Kwasi Kwarteng’s tax cuts were the largest in 50 years

A planned increase to corporation tax was cancelled, a rise in National Insurance contributions was reversed, the basic rate of income tax was cut and the highest rate abolished. These measures — amounting to £45bn of tax cuts — were the largest announced by the UK since the infamous 1972 Budget by Anthony Barber.

Market reaction to the speed and scale of the tax cuts, the fact that they were unfunded and the lack of OBR oversight was swift.

By the evening of Friday, September 23, sterling was down 4 per cent against the dollar to below $1.09.

Chart showing sterling’s decline since the second world war

On the following Monday, September 26, sterling reached an all-time low against the dollar.

Chart showing most market reaction was seen in gilts

Most of the reaction to come in the weeks that followed was confined to the UK government bonds, or “gilts”, market.

Gilt yields are important as they indicate the cost of any government borrowing. The yield on the 30-year gilt rose from 3.5 per cent prior to the “mini” Budget to over 5 per cent on September 27.

Gilts provide a baseline level of general interest rates, so the rise in yields pushed mortgage rates higher and created a liquidity crisis for pension funds.

Final-salary pension funds, particularly those using liability-driven investment hedging strategies, would have had to sell gilts at low prices (which move inversely to yields) to remain solvent.

FT explainer article on Kwasi Kwarteng’s mini-Budget bond market impact

On September 28, the Bank of England was forced to reverse their own gilt selling programme and intervene heavily in the gilt market.

Explaining its intervention, the central bank stated: “The overall move in 30-year gilt yields on September 28 of 1.27 percentage points was larger than the annual trading range . . . in all but four of the last 27 years.”

Around this time, the IMF criticised the fiscal plan saying the UK’s targeted tax cuts “will likely increase inequality”.

John Burn-Murdoch column: ‘The Tories have become unmoored from the British people’

An FT analysis by chief data reporter John Burn-Murdoch showed how far to the right on economic issues the Tory party had become, both compared with other parties and its own voters.

Chart showing the Conservatives have become unmoored from the British public on economics

The mayhem in markets, with implications for people’s mortgages and pensions, alienated many voters. A YouGov/Times poll published the week after the “mini” Budget showed a 33 point lead for the Labour party, the highest since the 1990s.

Ministers came to the defence of the measures. Business secretary Jacob Rees-Mogg claimed that the Bank of England was responsible for the market reaction, by not raising interest rates faster.

Under sustained market and political pressure, the government began to backtrack. On October 3, the top rate of income tax was restored, then on October 14 Truss sacked Kwarteng and announced a U-turn on corporation tax.

Three days later, new chancellor Jeremy Hunt ripped up almost all of the remaining tax cuts in a break from protocol, which was communicated in a statement before the London markets opened.

Liz Truss announces her resignation outside Number 10

Despite initially indicating her determination to fight to stay, Truss delivered her resignation on Thursday saying she was elected on a mandate to create economic growth but was not in a position to deliver it.

In the wake of her quitting, EU leaders insisted it was important for the UK to return to political stability as soon as possible.

Jeremy Hunt — © Simon Walker/HM Treasury

What now?

Sterling and gilt markets have been relatively stable since Hunt’s changes. The Conservative party intends to take a week to elect a new leader and UK prime minister.

Chart showing the premium on the UK government’s borrowing costs rising

However, government borrowing costs remain elevated, which some commentators have dubbed the “moron premium”.

A fiscal statement — scheduled but subject to the new PM’s approval — with full OBR costings and forecasts is set for October 31.

Chart showing a sizable hole remains in the UK’s public finances

But the crisis is far from over. The new chancellor has signalled tax rises and a new round of “austerity” to plug the £40bn hole in the public finances. Expected reductions in support for energy bills will add further pressure to UK household and business budgets.

The “Trussonomics” experiment appears to have aggravated an already perilous economic situation.

Data and graphics by Steve Bernard

This post was originally published on Financial Times