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Leading Economists Insist Government Financial Plans Worsened Economic Chaos

Ministers have denied the mini-budget prompted chaos in the UK markets (Alamy)

5 min read

Several leading economists have told MPs they believe there is "absolutely a UK component" to the current market chaos after ministers blamed global financial pressures rather than their controversial "mini-budget".

Appearing before the Commons Treasury Committee, Sanjay Raja, chief UK economist for Deutsche Bank said Chancellor Kwasi Kwarteng's unfunded tax cutting plans were the "straw that broke the camel's back" in the UK markets amid wider global turmoil.

Government ministers have repeatedly claimed the crisis in the UK financial markets, which saw the value of the pound plummet immediately after Kwarteng presented his plans, were the result of global pressures. 

On Tuesday Business Secretary Jacob Rees-Mogg claimed the mini-budget was "not necessarily" responsible, suggesting the Bank of England's interest rate strategy could also been partially to blame. The Bank of England were forced to step in to shore up pension funds which faced collapse in the days after Kwarteng's announcements after a fire sale of government bonds.

Pension fund managers found themselves unexpectedly at the center of a market storm – not a usual spot for usually volatility-adverse pension funds – after certain products, known as Liability Driven Investments (LDI) faced liquidity issues.

LDI is a common investment approach used by managers of defined benefit pension funds, which in simple terms means the amount that they have promised to pay for people's pensions. LDIs are used to buy government bonds, known as gilts, which typically offer low-risk, low-return investments, to help them offset losses they might incur on other investments or because of market shifts.

Gilts are a means for the government to borrow money with investors buying them up in exchange for a set, low-rate of return later down the line. They are seen as a low-risk investment because they are backed by the UK government, but because gilts are usually issued at a fixed interest rate they are closely tied with inflation, meaning that higher interest rates make them less attractive.

Raja said that while there was "absolutely a global component" to the turbulence, the "small surprises" from the "mini-Budget" had a "bigger impact" on the UK economy, leading to the potential for higher interest rates in the future.

"You throw on the ["mini-Budget"], you’ve got a sidelined financial watchdog, you’ve got lack of a medium-term fiscal plan, one of the largest unfunded tax cuts we’ve seen since the early 1970s, it was kind of the straw that broke the camel’s back," he added.

The economists added that those impacts, including rising borrowing rates on UK government debt, were linked to market fears that the Chancellor's plans to cut taxes would lead to a much higher rate of government spending, which prompted the fall in the pound and the sell off of gilts.

As a result, pension funds were asked to find the cash to cover the change in their hedging arrangements, putting pressure on the funds, and in response decided to sell off their gilts, putting further pressure on the market as sellers outstripped buyers.

In the days after the Chancellor's "mini-Budget", there were fears those pension funds would not be able to find that cash and could collapse, prompting the Bank of England to make a major intervention by promising to buy up billions of pounds worth of these gilts. Their decision calmed markets, reducing gilt yields and allowing funds to stabilise their positions.

But the backstop is only set to run until Friday, with Bank of England Governor Andrew Bailey telling funds to "get this done" and rebalance their investments.

Torsten Bell, chief executive of the Resolution Foundation think tank told MPs on the Committee today that it was "very clear" that reaction in the gilt markets were linked to the government's wider financial plans.

"I don't think anybody who is spending their time, and unfortunately too many people are spending their time looking at UK gilt markets right now, thinks that there is only an international, global element to what is going on," he said.

"Look at the change over the last year, look at the change particularly since September... It is very clear that there is a UK specific element to what is going on. That is what the Bank of England is telling you. I would focus on what they are saying."

There have also been impacts on the housing markets as the market turbulence spooked mortgage lenders who fear that UK interest rates could rise to help combat soaring inflation. The UK's interest rate hit 2.25 per cent in September, leading to higher rates for borrowers, but fears around the government's financial plans have prompted expectations of higher rises in the coming months, with interest rates possibly hitting six per cent next year.

In response to those concerns, several major mortgage lenders removed their products from the market in the days after Kwarteng's announcement, before returning them at higher prices.

It means a new two-year fixed mortgage is currently sitting above six per cent, up from 4.74 per cent on the day Kwarteng announced his tax-cutting plans, and up from 2.34 per cent in December.

For those coming to the end of their fixed term period, an interest rate rise to six per cent next year would, according to Labour, result in an average £498 monthly rise on their mortgages, with higher rises for those in less-affordable areas, such as London.

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