The damaging effects of Liz Truss’s radical economic experiment are still being felt in the UK, and particularly in the mortgage market, more than two months after she resigned as prime minister.
Efforts by Rishi Sunak to reap a “dullness dividend” by adopting an orthodox economic stance on the public finances have unwound much of the premium that international investors demanded on UK government borrowing costs following Truss’s disastrous “mini” Budget in September.
But experts said the mortgage market, where UK homeowners face more expensive deals following Truss’s premiership, would take longer to fix.
The “mini” Budget that Truss’s chancellor, Kwasi Kwarteng, unveiled on September 23 focused on £45bn of unfunded tax cuts — the largest such reductions in 50 years.
Concern over the amount of sovereign debt needed to finance the tax cuts sparked a big increase in UK government borrowing costs, and sterling’s value tumbled against the dollar.
At the height of the Trussonomics experiment, the additional yield that investors were demanding on government bonds became known in financial markets as the “moron premium”.
The City of London could not understand why the Truss government sacked Treasury permanent secretary Tom Scholar and failed to ask the Office for Budget Responsibility, the fiscal watchdog, to scrutinise the “mini” Budget.
Much of the additional UK government borrowing costs relative to peer countries have now been nullified, said Dario Perkins, managing director of consultancy TS Lombard, who coined the phrase “moron premium”.
“During the Truss regime it was clear that UK policy incompetence was becoming a market theme. The current administration has done a decent job of removing that.”
Liz Martins, an economist at HSBC, said the financial market reversal of most of the moron premium “is like it was all a dream — bond yields have come back down and the pound is stronger than it was before Liz Truss became prime minister”.
The improvement in UK government borrowing costs compared with other countries is not complete, however.
Since Boris Johnson announced his resignation in July, UK government 10-year borrowing costs have risen more than 1.6 percentage points, compared with 1.4 percentage points in France and 1.2 percentage points in Germany. The premium the UK has to pay on 30-year government bonds is significantly larger, at more than 0.5 percentage points.
Using slightly different calculations, James Smith, research director at the Resolution Foundation, a think-tank, estimated 10-year UK government bond yields have risen 0.4 percentage points more than equivalent AAA-rated European sovereign debt since Johnson announced his resignation, which he said “equates to higher borrowing costs of around £5bn by 2027-28”.
If efforts by the prime minister and his chancellor, Jeremy Hunt, have eradicated much of the moron premium from the public finances, the same is not the case in the mortgage market.
Data from finance website Moneyfacts show the cost of the average two-year fixed rate mortgage deal rose from 4.74 per cent at the time of the “mini” Budget to 5.8 per cent just before Christmas. Rates on five-year fixed-rate deals rose from 4.75 per cent to 5.61 per cent.
These latest mortgage deals, while less costly than peaks recorded in mid-October, still show a sizeable premium compared with financial market expectations of Bank of England interest rates over the same period. Those expectations govern the cost of mortgage lending.
Homeowners are therefore paying the price for the Trussonomics experiment, and the Bank of England expects 4mn mortgages for owner-occupied homes to rise in price in 2023, with people on fixed-rate deals having to pay an extra £3,000 a year in interest on average.
Richard Donnell, head of research at property website Zoopla, said it was clear that a “mini” Budget effect continued to have an impact on the mortgage market, adding this was primarily a result of lenders deciding to withdraw from offering loans at competitive rates.
“The ‘mini’ Budget fallout added another 1 to 1.5 percentage points to mortgage rates . . . and brought the housing market to a near standstill in the fourth quarter,” said Donnell. “Christmas started early, with demand [for home purchases] down 50 per cent on last year.”
The BoE’s view appears to be that the chaos of Truss’s period in government allowed banks and building societies to rebuild profit margins on their mortgage deals and reduce competition, to the detriment of households.
Jon Cunliffe, BoE deputy governor for financial stability, said this month that cheap mortgages before the “mini” Budget stemmed from banks wanting to increase market share, leading to profit margins becoming “very compressed”. That was no longer true, he added.
Meanwhile, Andrew Bailey, BoE governor, has been vocal about other damage from the Truss government that is likely to linger.
Referring to his attendance at the IMF annual meetings in October, he told MPs the following month: “We have damaged our reputation. People have said ‘We did not think the UK would do this’.”
Blaming the “mini” Budget, Bailey added: “It will take longer to rebuild that reputation than it will be to correct the gilt curve. We have to tread carefully.”
But not all the consequences of Trussonomics were bad, according to Paul Dales, an economist at Capital Economics.
He said Truss and Kwarteng had demonstrated to everyone what to avoid doing in government, adding: “If there’s a positive to come out of the whole embarrassing affair it may be that politicians should now understand that there is no magic money tree.
“That’s important for the current government, perhaps a future Labour government and governments overseas.”
