It is not just with its welcome approach to tax and fiscal policy that this Government marks a dramatic break with its Tory predecessors. It is also rightly much more aggressive when it comes to monetary policy and tackling the scourge of inflation. Liz Truss and Kwasi Kwarteng, have both repeatedly stated that the Bank of England should have done more to combat price rises, and tensions were evident in yesterday’s first post-interest rate decision exchange of letters between the Governor and the new Chancellor.
Unhelpfully for a new Prime Minister who had previously insisted a recession wasn’t inevitable, the Bank announced that, in fact, we were already in one. It chose to raise interest rates by just 0.5 per cent, snubbing those who believe more should be done faster. This was at odds with the strategy of America’s Federal Reserve and led to a further slump in the value of the pound. The Bank is choosing to focus its anti-inflation efforts on Quantitative Tightening, even though this involves selling gilts at a time that the Exchequer will need to issue a lot more to fund a much larger budget deficit.
The language used by Kwarteng in response was diplomatic, but implied serious displeasure. It certainly differed dramatically from Rishi Sunak’s more emollient approach. The Chancellor highlighted the fact that inflation is increasingly domestically generated for both goods and services, rather than just driven by Russia’s invasion, and therefore more directly the Bank’s fault. He spoke of the need for “forceful” action to regain control of inflation, implying that the Bank had lost its grip.
It is hard to remember a time when a government, any government, especially one behind in the polls, wanted higher rather than lower interest rates. But the reality is that most people don’t have a mortgage, and there is widespread public support for higher rates, especially among savers. More importantly, Kwarteng and Truss aren’t Keynesians: they are supply-siders who understand that years of ultra-low interest rates have propped up dud investments, encouraged myriad unviable projects and depressed productivity and wage growth.
They are staunch supporters of the Bank’s independence, as the Chancellor emphasised again, but in return they expect to deliver on its agreed mission, which is to keep inflation to 2 per cent, not to allow it to surge to 11 per cent.
This was merely an early skirmish in what is likely to be a lengthy and bitter battle between Truss’s buccaneering supply-siders and an economic establishment that has rested on its laurels for far too long.