Truss and Kwarteng are learning the hard way about who really runs the show

Britain’s economic policy will be framed to fit in with what the backbenchers will vote for and what the markets will pay for, writes Hamish McRae

There are a few weeks where Kwarteng has the opportunity to show he can learn (Pool/AFP/Getty)

Liz Truss and Kwasi Kwarteng are learning the hard way who runs the show, and it is not them. UK economic policy will be framed to fit in with what the backbenchers will vote for and what the markets will pay for. They may have a bit of leeway over timing, if the plan by the chancellor to stick to the 23 November date for the Budget holds and it does not have to be brought forward. But everything they do has to pass those twin tests.

We have already seen the cut in the 45 per cent top tax rate to 40 per cent reversed under pressure from the backbenchers. But that does not change the numbers to any significant effect, with the independent Institute for Fiscal Studies pointing out that the estimated £2bn of revenue a year lost was a rounding error in the context of a £45bn tax package. The problem was that it did not pass the smell test: it just seemed wrong to do something like this at this time.

Whatever the chancellor does or does not do in the weeks ahead – notably on benefits – it will have to be credible to MPs sitting behind him in the Commons.

In the next few days and weeks, the attention will shift from what the party will back to what the markets will charge. What seems to have happened, and it is early days yet, is that interest rates are going to be between half a percentage point and one percentage point higher than they would have otherwise been. You can see that in the gilt market. The wild gyrations of last week have subsided, and the yield on 10-year government stock, gilts, was around 3.85 per cent.

That is a relief from the 4 per cent plus level of a few days ago. But the decline is the result of a fall in the interest rates on global bonds, not a rise in confidence in this government. There is still a risk premium that you can measure. The yield on 10-year US government debt was around 3.58 per cent. So the UK government, or more accurately we as taxpayers, have to pay roughly 0.25 per cent more than Americans.

Now look at those rates at the beginning of September. For us, the yield was 2.89 per cent, while for Americans it was 3.26 per cent. So we could borrow 0.37 per cent more cheaply than they could in the US. The interest rate penalty that the world markets are charging for the tin-eared mini-Budget of the chancellor 10 days ago is around 0.6 per cent. That may seem a small penalty, but the national debt at the end of March was £2,365bn, and the rate the government has to pay pulls up the rate we all have to pay – businesses, homebuyers, everybody. This is not the act of the Bank of England in raising rates – and the latest money market estimates are that they will reach between 5 per cent and 6 per cent next year. It is the market response to Kwasi Kwarteng.

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What can he do to claw back this serious penalty we all have to pay? I had hoped that bringing forward the Budget, together with the Office for Budget Responsibility’s forecasts for the economy and the deficit, would show some sensitivity to market opinion. But sticking to the timetable knocks that back. Right now, for all sorts of reasons, financial market confidence is shot to pieces. The UK has made matters worse, but everyone is worried about other things too.

The general view in the US is that recession is unavoidable next year and that the Federal Reserve may push up rates too fast. Europe is in some ways in a worse position thanks to its dependence on Russian gas. The past couple of days have seen a modest return of confidence, but it would be naive to expect that to last. Still, there is a breathing space for our embattled chancellor.

So there are a few weeks where Kwarteng has the opportunity to show he can learn. That means forgetting about political rhetoric because no one is impressed by that. It means making someone internationally respected head of the Treasury. It means coordinating whatever he is doing with what the Bank of England reports from the battlefront of the financial markets. Most important of all, he has to find a way to make the fiscal numbers add up.