Thread by @Joe_Mayes

What's just happened to the UK economy? A thread on how we got here, and what's next for Liz Truss and Kwasi Kwarteng... 1/

Think back to the summer. Liz Truss and Rishi Sunak fought to be prime minister with competing visions on the economy. Sunak = be cautious, disciplined, bring down inflation. Truss = go for growth, borrow more, reject Treasury orthodoxy... 2/ bloomberg.com/news/articles/…

Truss enjoyed a big polling lead through the contest and ultimately won. Financial markets were already getting nervy over the summer, with UK assets declining in anticipation of her victory... 3/ bloomberg.com/news/articles/…

To be sure, it wasn't just the prospect of a Truss premiership hitting the £. The US $ has been v strong in recent months, due to the Federal Reserve aggressively hiking interest rates (faster than the Bank of England).. 4/ bloomberg.com/news/articles/…

Quick explanatory pause -- if US interest rates are higher than UK interest rates, that boosts the $ versus the £. Investors want to put more of their money in $-denominated bonds (bigger returns) than £-bonds, so they buy $, sell £ 5/

It was in this context that Liz Truss took the keys to No 10. Markets sceptical, the US economy strong, watching closely for her to unveil her economic plans. These were delayed by the national mourning period for Queen Elizabeth II... 6/ bloomberg.com/news/articles/…

It all comes to a head on Friday when Chancellor Kwasi Kwarteng reveals their plan, including biggest tax giveaways in half a century and extra £70 billion of government borrowing to pay for subsidising energy bills. It really spooks financial markets.. 7/ bloomberg.com/news/articles/…

Why? It's worth remembering that markets are like a beauty contest. You're constantly being judged against what your peers are doing (US, France, Germany, Japan etc), where investors could also be putting their money. So you must be very careful about... 8/

Sending out negative signals for investors which make you look less safe, trustworthy than your peers. *Perceptions are crucial*. But the Kwarteng plan had various red flags which were punished, including.. 9/

- Not publishing an independent fiscal forecast from the Office for Budget Responsibility (looked sketchy)
- Not announcing a medium-term plan to bring the public finances under control (looked like abandoning discipline).. 10/ bloomberg.com/news/articles/…

It was also against the backdrop of having fired the most senior civil servant in the Treasury, Tom Scholar. Again, this was a negative signal for markets, another blot on the Kwarteng/Truss copybook and their perception of trust on the economy 11/ bloomberg.com/news/articles/…

So the markets deliver their initial brutal verdict, £ slumps, UK bonds fall. Kwarteng then makes matters worse over the weekend by saying he wants to press ahead with more tax cuts -- amplifying the message and gung-ho approach that spooked markets 12/ bloomberg.com/news/articles/…

So the markets open on Monday and £ crashes to all-time low against the $. £ weakness has a significant real-world harm for the UK -- it makes imports more expensive and Britain imports a lot more than it exports. That means higher prices in shops... 13/ bloomberg.com/news/articles/…

Meanwhile the UK's borrowing costs started to rise quite alarmingly. (Quick explanatory pause - when bonds are falling, their `yield' rises eg the debt interest you pay on the bond. Falling govt bonds = higher costs of borrowing = bad for govt...) 14/ bloomberg.com/news/articles/…

And especially given the govt needs to borrow an extra £70bn to pay for its big energy support package. Now is a particularly bad time for borrowing to be more expensive, and that's why charts like these worry Tory MPs... 15/

https://twitter.com/Joe_Mayes/status/1574367904744833027

The real-world harm of high government borrowing costs = more money spent on servicing your debts in interest payments, rather than on public services, schools & hospitals etc. Kwarteng told MPs y/day that a key metric he watches is borrowing costs... 16/

https://twitter.com/kitty_donaldson/status/1574785340568641540

So Kwasi and the Bank of England go into attempted stabilization mode. On Monday they both put out statements trying to reassure the markets, with limited success.. 17/ bloomberg.com/news/articles/…

Situation calms a little on Tuesday, but still very volatile. Then the International Monetary Fund comes out and gives the UK a slapdown over its economic plan, a big embarrassment for a major economy... 18/ bloomberg.com/news/articles/…

And then we come to today, when the Bank makes an emergency intervention, saying it will step in and stave off a crash by buying long-dated bonds. It was looking very hairy this morning because.. 19/ bloomberg.com/news/articles/…

Pension funds particularly were in a bind. They're some of biggest holders of long-dated govt bonds and had obviously seen the value of those plunge in the last few days. They really needed help (read this for explanation on margin calls) 20/ bloomberg.com/news/articles/…

So what now for Kwarteng and Truss? They've created a situation verging on a financial crisis, requiring the central bank to step in to make amends for their economic plan. Their options are... 21/

1) No U-turn, battle on, hope the markets improve, ride it out. This strategy effectively relies on quite a bit of crossing of the fingers -- not sustainable if the markets continue to move against them.. 22/

2) U-turn, drop parts of the economic plan (eg row back on the top rate tax cut, shift strongly and relentlessly to a message of fiscal prudence), apologize, say you tried to do too much too quickly, bite the bullet, hope markets reward you (not guaranteed).. 23/

And that's it really. There's little else for it. Truss and Kwarteng are currently sticking to 1). Whether that's sustainable will depend on behaviour of the markets -- and whether her MPs allow her to go on. Tory conference will be interesting... ends/ bloomberg.com/news/newslette…

Thursday update: Truss firmly sticking to option 1) in BBC interviews this morning. £ is down ~1%. UK government bonds fell as Truss spoke. Market slide continues... 25/ @EllenAMilligan bloomberg.com/news/articles/…

Late Thursday update: £ ends the day by stabilizing. It was down as much as 1.2% earlier, but was up 1.8% at $1.10 as of 5pm. Still a volatile situation, markets watching every word from Truss and Kwarteng... 26/ bloomberg.com/news/articles/…

Friday update: Things looking better. The £ has recovered to its level before the Kwasi mini-budget. Why? The Bank of England intervention seems to have done the trick. Investors are now expecting.. 27/ bloomberg.com/news/articles/…

The Bank of England to push up interest rates faster in the near-term (see earlier tweet on why that’d boost the £). Quick explanation on what the Bank does.. 28/

The Bank’s main job is keep inflation (price increases in the economy) at 2% per year. It’s main tool to do this is interest rates. When it increases interest rates, that’s meant to reduce inflation. People put more money in savings, have to pay higher mortgages.. 29/

So there’s less money in the everyday economy buying stuff = less upward pressure on prices. Now, the BOE knows that a v weak £ pushes up inflation (UK imports become more expensive), so they would want to raise rates in response.. 30/

And the expectation of higher interest rates from the BOE is what’s helped the £ in the last few days. But obviously there’s an associated pain for the general public - looming higher mortgage costs 🥵 31/ bloomberg.com/news/articles/…

Truss and Kwarteng are also mulling cuts to public spending to stabilise the situation, in a bid to bring down government borrowing. That might reassure markets, but at what political/human cost.. 32/bloomberg.com/news/articles/…