The damaging effects of Liz Truss’ radical economic experiment are still being felt in the UK, particularly in the mortgage market, more than two months after she resigned as Prime Minister.
Rishi Sunak’s efforts to reap an “inertial dividend” by adopting an orthodox economic stance on public finances have borne much of the premium reaped by international investors for the UK government’s borrowing costs after Truss’ disastrous “mini” budget demanded in September, nullified.
But experts said the mortgage market, where UK homeowners will face pricier deals after Truss’ tenure, will take longer to adjust.
The ‘mini’ budget, unveiled by Truss Chancellor Kwasi Kwarteng on September 23, focused on £45bn in unfunded tax cuts – the largest such cuts in 50 years.
Concerns about the amount of public debt needed to fund the tax cuts triggered a sharp rise in the UK government’s borrowing costs and the value of sterling plummeted against the dollar.
At the height of the Trussonomics experiment, the excess return that investors demanded for government bonds became known in the financial markets as the “idiot premium”.
The City of London could not understand why the Truss government had sacked Treasury Secretary Tom Scholar and failed to ask the Office for Budget Responsibility to examine the “mini” budget.
Kwasi Kwarteng’s 23 September mini-budget focused on £45bn in unfunded tax cuts, the biggest of such cuts in half a century © `
Much of the UK government’s additional borrowing costs compared to peer countries have now been offset, said Dario Perkins, chief executive of consultancy TS Lombard, who coined the phrase “idiot’s premium”.
“During the Truss regime it was clear that the UK’s political incompetence was becoming a market issue. The current government has done a good job of eliminating that.”
Liz Martins, economist at HSBC, said the financial market reversal of most of the idiot premium “is like it was all a dream – bond yields are back down and the pound is stronger than it was before Liz Truss took office as PM”.
However, the improvement in the UK government’s borrowing costs relative to other countries is not yet complete.
Since Boris Johnson announced his resignation in July, interest rates on 10-year UK government loans have risen by more than 1.6 percentage points, compared with 1.4 percentage points in France and 1.2 percentage points in Germany. The premium that Britain has to pay for 30-year government bonds is significantly higher at more than 0.5 percentage points.
James Smith, research director at the Resolution Foundation, a think tank, uses slightly different calculations, estimating that 10-year UK government bond yields have risen 0.4 percentage points more than AAA-rated European equivalents since Johnson’s resignation, said “corresponds to higher borrowing costs of around £5bn by 2027-28”.
While the efforts of the Prime Minister and his Chancellor, Jeremy Hunt, have eradicated much of the idiotic premium from public finances, the same is not the case in the mortgage market.
Data from financial website Moneyfacts shows that the cost of an average two-year fixed-rate mortgage deal has risen from 4.74 percent at the time of the “mini” budget to 5.8 percent just before Christmas. Rates for five-year fixed-rate contracts rose to 5.61 percent from 4.75 percent.
While these latest mortgage deals are less expensive than the highs recorded in mid-October, they still represent a sizeable premium compared to financial markets’ expectations for Bank of England interest rates over the same period. These expectations determine the cost of the mortgage loan.
Homeowners are therefore paying the price of the Trussonomics experiment, and the Bank of England expects 4 million home mortgages to rise in price in 2023, with people on fixed-rate contracts paying an extra £3,000 a year in interest on average.
Richard Donnell, head of research at real estate website Zoopla, said it was clear that a “mini” budget effect would continue to impact the mortgage market, adding that this was primarily due to lenders flexing had decided not to offer loans at competitive interest rates.
“The impact of the ‘mini’ budget increased mortgage rates by another 1 to 1.5 percentage points. . . and nearly shut down the housing market in the fourth quarter,” Donnell said. “Christmas started early, with demand [for home purchases] 50 percent less than in the previous year.”
The BoE’s view appears to be that the chaos during Truss’s administration allowed banks and building societies to rebuild margins on their mortgage operations and reduce competition to the detriment of households.
Jon Cunliffe, BoE Deputy Governor for Financial Stability, said this month that ahead of the “mini” budget, cheap mortgages came from banks looking to increase their market share, resulting in margins being “very compressed”. That no longer applies, he added.
Meanwhile, BoE Governor Andrew Bailey has been vocal about other damage from the Truss government that is likely to continue.
Referring to his attendance at the IMF’s annual meetings in October, he told MPs the following month: “We have damaged our reputation. People said, ‘We didn’t think Britain would do that’.”
Bailey blamed the “mini” budget, adding, “It’s going to take longer to rebuild that reputation than it will to correct the gilt curve. We have to proceed carefully.”
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But according to Paul Dales, an economist at Capital Economics, not all consequences of trussonomy were bad.
He said Truss and Kwarteng showed everyone what to avoid in government, adding: “If there’s anything positive about the whole embarrassing affair, then politicians might now understand that there is no magic money tree.
“This is important for the current government, perhaps a future Labor government and governments overseas.”
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