What is happening in the financial markets now is as dangerous as what happened in October 2008. Unlike then, this does not relate to one or two failing institutions (though that is a crude summary of what happened). Rather, it is two-fold: on the financial side, the issue of government borrowing, how it is to be paid for and how a path back to some sort of fiscal stability to lay the foundations for growth are to be achieved. Politically, it is whether Britain’s governing and regulatory institutions have the authority to cope. 

One thing cannot be stated too often. 12 working days after the government’s fiscal statement the Bank of England still thinks there is a “material risk to the UK’s financial stability“. This is as bad in its potential impact on everyone in the UK as the prospect of every bank shutting its doors (what was feared would happen in 2008). Bluntly, it is worried about the solvency of pension funds, the impact on banks and the systemic risk this poses. (That this has become a concern suggests underlying structural issues regarding pensions, how they are funded, how their risks are managed and whether the authorities should have taken action earlier – the Bank was warned two years ago about the risks of Liability Driven Investment, for instance. It has also been criticised for its slowness in raising interest rates. But now – as in 2008 – the focus has to be on preventing failures causing systemic market upheaval. The time for fixing the structural issues will come later.)

These have come to a head against a background of inflation, low growth, high energy costs, restricted energy supply, the war in Ukraine and high government borrowing as a result of Covid. Separately, these are formidable challenges. Together, they would tax a government led by someone blessed with the wisdom of Solomon.

What has made it worse has been the government’s tin-eared response. Tin-eared in 4 ways:

1. Talk of growth with no explanation of how its preferred measures will lead to this. The aim is splendid. The diagnosis of why it has not happened poor. The remedies non-existent.
2. The undermining of the independent governance designed to reinforce the government’s credit. (For instance, the attacks on the Bank of England, sacking the Treasury’s Permanent Secretary, refusing to let the OBR publish its assessment, limiting or delaying detailed Parliamentary scrutiny.)
3. The lack of detail about the spending side of the plan. 
4. The desire to avoid scrutiny and the delays in providing the full picture.

The second has been a critical mistake. In finance, confidence matters. Once it goes, it is hard to retrieve or only at a higher than normal – or ruinous – cost. More severe measures will likely be needed to recover that confidence than if it had not been damaged in the first place. We are seeing that already with government debt. Borrowing costs are at a 15-year high. Voters are seeing it in their mortgage rates. More worryingly, 3 Bank of England figures have come out publicly in recent days to say explicitly that it was the government’s financial statement  which caused the market reaction. That suggests both a lack of understanding within government and an unwillingness to listen to what it is being told. It is not optimal for the Bank of England to be admonishing the government at such a time. The authorities should be working together – not pointing fingers or getting their excuses in early.

There are signs that the government is starting to realise this: the appointment of a a treasury insider and bringing forward the next statement to 31 October. Britain’s creditors now expect large painful spending cuts if the public finances are to be put on a sustainable path. If not, the proposed tax cuts will have to be reversed. Tax increases may be needed. None of these are desirable. The political coalitions against each of them would make the Anti-Growth coalition seem like a tiny groupuscule. But some combination of them will be needed. Does the government have the political will and authority to do what may be necessary but unpalatable?

Meanwhile, we have to hope that the Bank’s efforts work and that they, the new Treasury team and the government understand the extent of the dangers and are working together. If a week is a long time in politics, what will 20 days until the next statement feel like? The longer the Bank intervenes, the more its efforts are seen to be ineffective or insufficient (watch what happens after Friday when its current intervention is meant to end) the greater the chances of the 31 October statement being brought forward. What will that do to confidence? Tick tock.

Cyclefree