News is dominated by last week’s fiscal event. It was bold, it was brave, it was promised during the leadership campaign. But it has caused turmoil on the financial markets.
I want to be absolutely clear about this. The principles that it delivers are ones that I support. The principle that people keep more of the money they earn is a good one. The principle that we focus on growth and improved productivity is a good objective. The idea that government departments focus on improved economic output benefits us all. But (there’s always a “but”) the timing of these interventions could not have been worse.
The huge economic problem we are facing is that of stagflation – high inflation and recession at the same time. Tackling inflation – the cost of living crisis – has to be the first priority and the Bank of England has just one measure to deal with this: interest rates. Hiking borrowing rates reduces money supply – the cause of inflation – and so inflation comes under control. But if the government, at the same time, increases money supply, the Bank has to hike rates further.
This approach by the new government, in normal times, would be brilliant. But it needs several things to go right for it to work.
First, the tension between the Bank’s monetary tightening and the government’s fiscal loosening must be resolved. Second, to achieve the growth, the free cash needs to be invested in productive projects. More buy to let properties will not deliver the outcome needed. Third, has the government chosen the right interventions? Removing the bankers bonus cap (which is not about paying bankers more, merely changing the ratio between base pay and variable pay) is good for our global financial services sector. But reintroducing the bank levy, where banks pay an 8% tax surcharge is counterintuitive. Fourth, the markets need to behave for this to work. The UK government now pays more to borrow money than Greece or Italy. And finally, this all has to work. With debt going up, the growth plan has to cover that debt.
The focus will be on mortgage rates. With average mortgages at around £250,000, each percentage point hike in interest rates is an increase of £2,500 on annual mortgage bills. And this affects business borrowing.
As I say, the principles are absolutely right. But this has got to work when the headwinds are in the wrong direction.