The lady vanishes: the Truss agenda is dead

‘Governments don’t control markets,’ the new Chancellor, Jeremy Hunt, likes to say. But there are times when markets control governments. The market, or the fear of how the market might react, is now the driving force in British politics. It explains the dramatic developments of the past week and will determine the new Prime Minister’s fate.

Last month’s ‘mini-Budget’ was doomed because it required that the government borrow £70 billion more than had been planned. This money would have to be raised in the gilts market, and Liz Truss and Kwasi Kwarteng assumed that the markets would be happy to continue to lend so much at such low rates. But they missed the fact that attitudes were changing. The markets took fright at how cavalier the government’s approach seemed to be, promising tax cuts without any accompanying spending cuts. The cost of government borrowing spiked. The whole plan became unworkable.

Since then, the government has been desperately trying to calm the markets. Kwarteng and the corporation tax cuts were offered up as a blood sacrifice on Friday last week. But as the markets closed that evening, it was clear that these measures had not been enough. The market wanted more.

Hunt spoke to the governor of the Bank of England, the Office for Budget Responsibility, the head of the Debt Management Office and Treasury officials. As he put it to MPs on Monday: ‘The conclusion I have drawn from those conversations is that we need to do more, more quickly to give certainty to the markets about our fiscal plan.’

In the end, the new Chancellor ended up shredding almost the entire mini-Budget. Even the energy bailout that Truss had been trying to use as her dividing line with Labour will only last for six months.

It is a sign of how serious the situation was and how dominant the market is that Truss felt she had to go along with these measures. I am told that she pushed back remarkably little when Hunt set out what he intended to do.

Truss has not only been forced to jettison her closest ideological ally, Kwarteng, and their mini-Budget, but also the entire platform on which she ran for the leadership. A politician who spent her time railing about Britain’s high tax burden is going to increase it further. A leader who styled herself as a disruptor is now trying to bring about stability at any cost.

Truss finds herself in an extraordinarily weak position. She still has the seal of office, but little more. Her governing agenda is dead. She is not even regarded as first among equals any more. Her Chancellor, though far too polite to mention it, holds the whip hand. She cannot afford to lose him. If Hunt goes, borrowing costs would surge to unsustainable levels. Her premiership now depends on keeping him on board. Hunt, one of the nicer people in politics, will not publicly humiliate her. But the dynamic is clear. Just look at how the triple lock – which Truss committed to as recently as party conference – is up for discussion again.

Truss has told one influential figure that she believes she is safe because the party would not be able to agree on a candidate to succeed her. She told another that she had taken the tough decisions a prime minister has to take and should be allowed to get on with the job. She is right that there’s no obvious unity candidate. But since the Tories are 30 points behind in the polls and on course for a worse election result even than in 1997, this fact won’t save her for ever. A senior backbencher says that one of the few things MPs can agree on is that Truss mustn’t lead the Tories into the next election.

Why do the markets have this kind of power over the UK, and now the Tory party? Britain relies on them to fund government borrowing. Government ministers like to point out that the UK’s debt to GDP ratio is one of the lowest in the G7. But in Japan – where the debt to GDP ratio is 231 per cent – nearly all the debt is domestically owned. By contrast, more than a quarter of UK government debt is owned by foreign investors.

Instead of running a current account surplus, the UK relies on capital inflows from abroad to fund itself, meaning that a loss of confidence among the foreign investors becomes crippling. Mark Carney’s phrase about the ‘kindness of strangers’ was poorly chosen. But he was on to something: the UK heavily relies on foreigners having confidence in its government and institutions.

When a crisis hits, extra power is handed to those who it is thought know the markets best. When Hunt went to Chequers on Sunday to see Truss, he wasn’t trying to present a political fix but a solution that would reassure the markets. Hunt’s determination to signal that taxes will rise and spending will be cut, the least politically appealing combination possible, shows how much markets trump party politics at the moment.

Hunt has had a successful career as an entrepreneur but not even his greatest admirers would claim that he has a unique insight into sentiment in the bond markets. Instead, he is being guided by those institutions of the state that are thought to understand best how they react. These are the Treasury, the Bank of England and the Debt Management Office.

The irony is that, despite having campaigned against the Treasury orthodoxy and talked about reviewing the Bank of England’s mandate, Truss has handed these institutions more power than they have had in living memory. It would be a brave minister who would now contradict their advice on what is needed to calm the markets. Indeed, the word in Whitehall is that one of the things that sealed Kwarteng’s fate was a view in the institutional Treasury that market confidence could not be recovered while he remained in place.

Of course, no one can quite know how the markets will react to each and every decision. But the imperative of satisfying them means that it is becoming the clincher in any argument. For instance, Hunt argues that Truss should not be removed as Prime Minister because ‘the one thing we do know is that markets don’t like political instability’. Meanwhile, others argue that the £10 billion ‘muppet premium’ (to use the more polite version of the City shorthand) that the UK is paying on its borrowing costs won’t go away until a new prime minister is in place.

The market’s new role as the arbiter of policy will shape British politics for the rest of the decade. It will mean that a premium will be placed on policies being paid for. The Truss blow-up has discredited the idea of borrowing to fund permanent tax cuts for a generation. At the same time, the experience of the past few weeks will make it much harder for Labour to argue that it would be easy to borrow to fund new, permanent day-to-day spending commitments.

G7 economies are not meant to end up in the mess that the UK is in, being forced to make emergency statements before the markets open. The damage done to the UK’s reputation by the events of the past month will take time to repair. Most measures from the mini-Budget are gone, but concern will linger over how such a fiscally reckless plan could have ever been presented to parliament.

The problem for the government is that the loss of market confidence means that it now needs to go further than it otherwise would have in order to appease them. The plans presented on 31 October will be a political horror show.