The five Ms threatening Liz Truss’s economic reset

Treasury orthodoxy is back. After a “mini” Budget which spooked markets and sank gilts, reassurance is the mantra. In the past week, the Truss government which spent the summer denouncing the wrongheadedness of the economic establishment has gone out of its way to cleave to the very bodies it blames for the UK’s decline.

Having derided and shut out the independent Office for Budget Responsibility from last month’s calamitous and rushed fiscal statement, the chancellor Kwasi Kwarteng has now made it the arbiter of his entire fiscal strategy. The most senior official at the Treasury, chosen to replace the establishment veteran sacked a month ago, will not after all be a dynamic, heterodox outsider but a man who has spent most of his career there. The Bank of England has staged three interventions in a fortnight to shore up the gilt markets. The institutions Truss once rubbished now hold the mortgage on her future.

The medium-term fiscal plan — the how-we-pay-for-it part of the government’s tax cutting strategy — has been brought forward to the end of October, to precede the Bank’s next interest-rate-setting meeting in the hope of heading off excessive increases. The most politically egregious, though fiscally minor, tax cut, abolition of the top rate of income tax, has already been ditched in the face of a backbench revolt. Truss is now reaching out to MPs.

The prime minister has not abandoned her core strategy of borrowing to cut taxes. “We need to work closely with the OBR but we are not backing down. We do need to do things differently,” said one close ally. But she has reluctantly accepted that credibility demands more than defiantly jabbing a finger at the Laffer curve.

Some Tory critics are encouraged by the change of tone. Mel Stride, a former Treasury minister, detected “a fundamental shift towards conciliation re the party and support re institutions”. Others are less sanguine. “I just don’t see a way out of this,” says one ex-minister.

For this reset may no longer be enough. The Truss government’s reboot is imperilled by a vicious circle of five Ms — money, markets, mortgages, majority and mandate.

First, money: the government has deepened its deficit with tax cuts it cannot afford while spending tens of billions on an energy rescue package. Meanwhile the interest costs on its debt are increasing. To satisfy the OBR and hopefully the markets, the Institute for Fiscal Studies says Kwarteng must find up to £60bn in cuts or new tax rises.

Kwarteng’s aim is to offer a five-year deficit reduction strategy with the harshest savings backloaded to the end of that period once, ideally, GDP is rising. The risk here is that neither the OBR nor the markets are impressed by growth projections or promises of savings down the line, while Tory MPs will fear an election fought under the shadow of looming cuts.

The market reacted to the holes in public finances. But more troubling is that investors are now treating the UK as an outlier among western economies. Among G7 nations only Italy’s 10-year Treasuries have a higher yield. Once a nation gets detached from the pack it is more exposed.

This leads to mortgages. Even as the government’s tax cuts promise more money in people’s pockets, it is clobbering many through rising interest rates. Millions of homeowners with a mortgage or loan face steep rises in monthly payments. While GDP growth is an abstract concept to voters, hits to household budgets are frighteningly real.

This plays on the nerves of fractious and frightened Tory MPs and the reality that, despite her notional parliamentary majority of 69, Truss really has no majority. The mood is mutinous, not least among the numerous discarded ex-ministers. Loss of faith in the prime minister’s judgment and terror prompted by plummeting opinion polls makes it hard to drive through contentious reforms. Few believe she has the votes for the real-terms cut to benefits ministers are considering. Truss was not elected by the country and was backed by fewer than a third of her MPs. This lack of a personal mandate means MPs elected under Boris Johnson’s manifesto have fewer qualms about rebelling.

This completes the negative loop: political instability deepens market concerns since it increases doubts about Truss’s ability to deliver savings. The incontrovertible law of politics — one that markets well understand — is that no premier, whatever their merits, can be an effective leader for long with no money, no majority and no mandate.

She must corral her MPs to calm markets. But one requires the other and few can see the big change that turns this vicious circle into a virtuous one without a harsh overcorrection from Kwarteng. So everything hangs on the fiscal plan, which is being hastily cobbled together and is still three weeks away. This requires a level of political and financial acumen not so far visible in this premiership.

Unless they find new ways to raise revenue, it may be that only a major retreat on some of the tax cuts (corporation tax perhaps) can restore market faith. But that is a last resort for Truss. It would create its own political crisis and probably require sacking the chancellor. She is truly hemmed in. One ex-minister argues she needs a slice of luck, a global event which changes the landscape. Alas, Truss does not look charmed and, besides, being lucky is not a plan.

robert.shrimsley@ft.com