Liz Truss ignored stark warnings from economists sympathetic to her growth strategy that the mini-budget that ultimately led to her downfall risked triggering a financial markets meltdown, the Guardian has learned.
Truss announced her resignation on Thursday after just 44 days in Downing Street, after a package of tax cuts and spending increases on 23 September rattled the markets, prompted a run on pension funds and sent the cost of mortgages spiralling.
But days before the start of her premiership, she was told by the economists Gerard Lyons and Julian Jessop that the markets were highly nervous and that she could face a crash if her policy changes were not handled with care.
Lyons and Jessop – who were supportive of Truss’s growth agenda – prepared a paper for a meeting at Chevening, the country residence of the foreign secretary, as Truss was, two days before she was announced as Boris Johnson’s successor on 5 September.
Also in attendance were Kwasi Kwarteng, who would be Truss’s chancellor, Matthew Sinclair, Truss’s economic policy adviser, and a third economist, Andrew Lilico.
The paper supported the idea that a new government needed to “hit the ground running” but repeatedly stressed the need to keep the financial markets onside.
Predicting the chaos that was to follow Kwarteng’s £45bn of unfunded tax cuts announced in his 23 September mini-budget, it said: “The markets are nervous about the UK and about policy options. If immediate economic policy announcements are handled badly then a market crash is possible.”
It suggested the best policy option for the UK was to have higher interest rates from the Bank of England to curb inflation and tax cuts and spending increases from the Treasury to mitigate recession risks.
“However, financial markets are concerned that any fiscal easing may add to inflation,” the paper added. “Thus, to keep the markets onside, it is important that fiscal policy is explained clearly, that fiscal actions now are targeted and, further ahead, are focused on the supply side of the economy.
“There is a need to convince the markets that fiscal action is necessary, affordable and non-inflationary.”
The hostile market reaction to the mini-budget led to most of the tax changes being reversed before Truss announced she was quitting. Kwarteng’s successor, Jeremy Hunt, is expected to announce spending cuts in a fiscal statement that is still scheduled to be held on 31 October, although that may change now there is another Conservative leadership race.
Jessop said on Thursday: “We were pretty clear the markets were very fragile and nervous. We said they needed to move carefully and stage the process. We said there was a significant risk of a market crisis, and that’s what happened. The overall strategy was right. The handling of it was terrible.”
Jessop said the opportunity to deliver on the growth strategy had now been lost. “Supply-side reforms need a strong, committed prime minister. We have gone back to what we were trying to avoid – a doom loop of tax increases, spending cuts and weak economic growth. A deep recession now starts to look more likely.”
Neither Lyons nor Jessop discussed the mini-budget with Truss after she became prime minister, although Lyons again warned Kwarteng of the need to beware the markets in the days leading up to the fiscal event on 23 September.
“I sent a further note to the chancellor after reading in the Sunday Times that a cut in stamp duty would feature as part of a mini-budget. The papers were making it out to be a much bigger event than the markets had expected it to be,” Lyons said.
He said the markets responded badly to the Kwarteng’s initial package but what tipped them over the edge was his announcement two days later that there would be more tax cuts to come. “The markets were febrile and that should have reinforced the need to be more careful.”
In their paper, Lyons and Jessop pointed to five policy challenges facing the new administration: “Addressing the energy crisis; inflation and the cost of living crisis; economic slowdown; departmental spending, particularly in areas of health, as higher inflation will have reduced the real spending power of planned government spending; and the need to avoid an imminent financial crisis and sterling crash by outlining policies to address the above.”
They added: “Fiscal responsibility is paramount – through a commitment to reducing the ratio of debt to GDP over time, thus ensuring solvency. Over time, public spending needs to be kept under control, with tax rates low.
“The fact that expectations about future economic and regulatory policy are low creates a great opportunity – but only if the new government hits the ground running. The only way to confront the present situation is to act decisively and not to hesitate, thus sending a clear message to the public and the financial markets.”
