Rishi Sunak can’t blame the financial markets for his spending cuts

On October 27, two days after Rishi Sunak was appointed Prime Minister, a familiar face returned to Downing Street: George Osborne, the former Chancellor, was invited back to advise Sunak’s Chancellor Jeremy Hunt.

Osborne is the architect of austerity, the Conservative belt-tightening strategy that helped the party win the 2010 general election. In an effort to help the UK recover from the financial crisis and “balance accounts,” Osborne cut spending and imposed drastic measures. wage freeze in the public sector.

Austerity was, for a time, reasonably effective, but we are still seeing the repercussions today. Figures released on Tuesday November 15 showed a 42% increase in the number of 25-34 year olds leaving the labor market since 2019 due to long-term illness – a consequence of real-term cuts to NHS spending over the years of austerity. And it’s worth wondering if the strategy actually worked. Since 2010, net debt has actually increased from 64.5% of GDP to 96.6%, according to the Office for National Statistics. Even before the pandemic, it was higher, at 79.5%.

In today’s budget, Hunt and Sunak are likely to reintroduce the policy aimed at filling a so-called fiscal black hole, caused partly by the pandemic and partly by Brexit, which was then exacerbated by the disastrous mini budget by Liz Truss and Kwasi Kwarteng. “The government I lead will not leave the next generation, your children and grandchildren, with a debt to settle that we were too weak to pay ourselves,” Sunak said in his first speech as prime minister. .

The mini budget, which included £45billion in unfunded tax cuts, was a botched attempt to tackle the UK’s weak growth problem. Sunak and Hunt are opting for a different tactic: tackling inflation, which is at 11.1%, a 41-year high. Saying he wanted to cut debt, Sunak said he saw the market reaction to the mini-budget, when long-term government bond yields soared above 5% for the first time in 20 years. , making this loan much more expensive, and had heard the message loud and clear: inflation must be brought under control. Reducing spending means that wage growth will slow, unemployment will rise and inflation will fall to more acceptable levels.

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But did Sunak correctly interpret the message from the markets? Quite apart from the fact that the fiscal black hole is the product of Tory-imposed rules, and no one can quite agree on its scale (estimates range between £50-70bn), there is also a risk that too much austerity will make the recession that is expected to last all of next year either longer or deeper (or both).

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[See also: What will be in Jeremy Hunt’s Autumn Statement?]

The UK suffered from weak growth long before inflation hit. Average annual GDP growth since the financial crash of 2008 has been 1%. Austerity is a surefire way to weaken it further, says Janet Mui, head of market analysis at RBC Brewin Dolphin, and it won’t be welcomed by investors. “Money markets want growth,” she says. “They want to see the UK managing its finances, but not to the point where everyone is not spending. It’s a very good balance. »

Giles Coghlan, chief market analyst at brokerage HYCM, adds:[The government has] must bring down inflation, balance their accounts, but they cannot do it at such a rate that they totally crush their growth and cause a strong restriction of the economy.

Sunak’s commitment to austerity also ignores the fact that the market reaction to the mini-budget was not just about what was announced, but How? ‘Or’ What it was announced, says Coghlan. Even before the mini-budget was introduced, markets were getting nervous as Truss “made some pretty outlandish statements about changing the Bank of England’s mandate, about maybe how we plan to assess the inflation,” he said.

The frenetic reaction after the mini-budget was more rational than it seemed. “The bond markets said, ‘Gosh, if you want to do that, that’s fine – but we’re going to position ourselves financially prudently, to allow that,’” Coghlan said. “It was the financial markets that said, ‘if this is the direction the UK economy is heading, we need to position ourselves to allow for an environment that fuels inflation’. The bond market reacted the way it did because that all this was underpinned by a lack of competence compared to what was expected.

In 2010, the United Kingdom suffered from weak growth. This time around, we are also plagued by high inflation. While Truss’ mini-budget tackled the first problem, Sunak and Hunt opted to tackle the second. Neither administration presented a good way to deal with the two. If Sunak and Hunt go too far in the other direction, investors could anticipate even weaker growth and start pulling out of the UK. “You need Solomon’s wisdom to get it right,” admits Coghlan. “I don’t envy anyone for having to make these decisions”

[See also: There is an alternative to austerity]