Why Kwarteng and Truss may be 'hugging' the Bank of England and OBR too late

Credit: PA

The Chancellor and the Treasury are "hugging" the Bank of England and the Office for Budget Responsibility again, in the words of a senior government member, having more-or-less repudiated them in the days before the ill-fated mini-budget.

But a return to more orthodox fiscal practices, that would include advance scrutiny by the OBR of spending and taxes, and announcing such before the Bank of England announces interest-rate changes, doesn't mean interest rates will stabilise at around current levels.

Far from it. Let's assume the Chancellor, Kwasi Kwarteng, brings forward his Medium Term Fiscal Plan to later this month (as per government briefings), from the scheduled date of 23 November (though eccentrically he yesterday told Liam Hannigan he was sticking to the 23 Nov date), that is likely to lead to another lurch upward in the cost of borrowing.

Interest rates set by markets and also the Bank Rate set by the Bank of England (whose next rate-setting meeting is 3 November) are both likely to continue to rise.

Here is why.

1) The chancellor knows there is no chance of the Office for Budget Responsibility significantly increasing the forecast growth rate for the economy on the back of Truss's plans to deregulate everything from childcare, to housebuilding, to infrastructure development to employee protections.

It's just not what the OBR ever does when governments announce initiatives to reform the structure of the British economy, because the execution risk is huge and evidence for efficacy is scant (and if you don't believe me, ask Sunak and all preceding chancellors).

So the rising quantum of debt won't be seen as less burdensome because of any acceleration in the size of national income or GDP: national debt will continue to rise as a share of GDP for years to come. But for how many years?

2) Kwarteng has been trying to reassure investors on sterling assets by telling them that government debt as a share of GDP will fall "over the medium term". Now the Bank of England's definition of the "medium term" is around two to three years.

And "three years" was Sunak's definition when he was chancellor. So if Kwarteng could credibly prove to investors that the UK's national debt would be falling in three years, that would reassure investors, and the Tories could begin to rebuild their reputation for fiscal competence, have seen that reputation seriously degraded by the trauma to the pound and government bonds caused by the mini budget.

But I am told it is unlikely Kwarteng can and will define his "medium term" as "three years", because for national debt to be falling over that time frame, there would have to be either serious public spending cuts this year and next, or tax increases that Truss has repudiated.

So it is highly likely that "debt falling over the medium term" will mean something like "over the five year lifetime of a government", because that gives Truss and Kwarteng scope to defer all initiatives to reduce the annual deficit to less than the growth rate of the economy till after the next election.

It defers the impact of tough choices till after an election that, right now, the Tories look set to lose by a significant margin. That's why, unless I am missing something, international investors may yet attach a risk premium to debt issued and sold by the government of Truss and Kwarteng.

Or to put it another way, the huge fiscal loosening of the mini budget may yet mean that the interest rates paid by all UK borrowers, the government, businesses and households, may end up higher than they would otherwise have been, as a direct consequence of the failure of Truss and Kwarteng to hug the Bank of England and OBR till after that momentous mini budget.

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