An economic Suez. For once, comparisons with the humiliation suffered by Sir Anthony Eden’s government in 1956 are appropriate because within 72 hours of becoming chancellor, Jeremy Hunt has abandoned not just most of Kwasi Kwarteng’s planned tax cuts but the government’s entire growth strategy.
Eden was gone within a couple of months of sending UK forces into Egypt to retake the Suez canal and then being forced to pull them out again in the face of the threat of US action to undermine sterling.
Even though Hunt’s tax rises have bought the prime minister some breathing space, Liz Truss’s capitulation to the forces of orthodoxy – the International Monetary Fund, the Treasury and the financial markets – has been just as complete. She will be lucky to avoid repeating Eden’s fate despite the breathing space Hunt’s tax increases have bought her.
Of the original package, only the reversal of the national insurance contributions increase and the cut in stamp duty have been spared Hunt’s axe. The cut in the basic rate of income tax has been shelved indefinitely. A freeze in alcohol duties from February now won’t go ahead. Nor will the cut in the tax on dividends or changes to the tax rules for the self-employed.
These changes – with last week’s announcement that corporation tax would, after all, go back up from 19% to 25% from next April and the U-turn earlier this month on abolishing the 45p top rate of income tax – will save the Treasury £32bn. The original package would have cost £45bn.
Just in case that wasn’t enough to mollify the financial markets, Hunt also scrapped the government’s commitment to a blanket two-year energy price cap. The pledge will now last only until next April, after which help will be targeted on the most vulnerable.
Nor will the latest measures be the end of the story. The chancellor made it clear there would be spending cuts to come in the next mini-budget on 31 October.
Hunt was always planning to announce tough measures but brought them forward because he feared a fresh onslaught on government bonds and the pound. To the extent that sterling subsequently rose on the foreign exchanges and the interest rates (yields) on gilts fell, the rolling back of Kwarteng’s tax plans will be considered a success.
Even so, the fact that gilt yields remain higher than they were before Kwarteng’s 23 September mini-budget reflects the damage caused to the government’s credibility. Investors are demanding a higher risk premium for holding UK assets.
Truss’s experiment with a rightwing form of Keynesian economics is now dead in the water. The original idea was that it made sense for the government to borrow more in response to an external shock – the sharp rise in energy prices prompted by Russia’s invasion of Ukraine.
The new policy turns the clock back, not only by five weeks but by 12 years, to the tough measures imposed by David Cameron’s government after the 2010 election. Austerity is back, but with one big difference. Twelve years ago, tax increases and spending cuts from the Treasury were offset by interest rate cuts and money creation from the Bank of England: this time they won’t be.
Hunt will be hoping his hardline stance will persuade the Bank to go easy on interest rate increases, and he might be right about that.
The Bank’s governor, Andrew Bailey, said at the weekend that the impact of the 23 September mini-budget would mean a hefty jump in borrowing costs in November. Hunt’s latest U-turns may result in the increase in borrowing costs being less severe.
But the days of rock-bottom interest rates are over. The Bank remains anxious about inflation – which will be boosted when the energy price cap ends in April – and the cost of borrowing is still going to rise in the coming months.
The upshot is that fiscal policy – what the Treasury does – and monetary policy – what the Bank of England does – are being tightened at a time when the economy is already struggling. The result will be weaker growth and a deeper recession.
