Abandoned Mini-Budget: A Simple Guide to Why the Plan Was Abandoned
The government has scrapped most key parts of its mini-budget after just over two weeks – but why has it had to react to financial market turmoil and why does it matter to mortgage payers and all the others ?
1. What did the government do?
The government’s job is to decide how much to spend on the things we need like the NHS, defense and education, but also how to pay for them – which it does by using taxes and borrowing money.
The government had announced help for citizens with their energy bills but the September 23 mini-budget did not explain how this would be paid for. In fact, he announced numerous tax cuts, suggesting that borrowing would have to increase even more than expected to make up the difference.
2. How does the government borrow money?
The government borrows money from investors with a type of contract known as a bond or a gilt – basically it promises to repay the money after a set period of time and pays a fixed annual amount to the investor as a fee.
Yield is a way of describing the amount the investor gets.
3. Where do the markets come from?
The term markets refers to investors, and the biggest players – those with the most money like investment banks, pension funds and insurance companies – worried about how much the government would have to borrow to pay his mini-budget.
They worried that the government wouldn’t be able to repay the money it owed them, and also that the loans would be worth less when paid back due to inflation (how much prices rise over time).
As a result, they weren’t willing to buy gilts for as much as investors had previously paid. It also meant that the government had to pay a higher return to persuade investors to buy new gilts – so it was more expensive for the government to borrow money.
4. Why were pension funds a problem?
In addition to buying gilts, some pension funds use them as collateral to borrow money from banks so they can pay people’s pensions – they then resell the gilts to repay the money to the banks.
But when the value of gilts fell after the mini-budget, pension funds had to sell more to raise the same amount of money to repay their loans. With more gilts sold, their value fell further and this risked creating a downward spiral that could have prevented some pension funds from paying their debts.
5. What did the Bank of England do?
The Bank of England is independent of the government but has instructions to maintain the country’s financial stability – which would have been in jeopardy if many large pension funds had collapsed.
He stepped in on September 28 and promised to buy gilts to keep their price from falling further – effectively acting as a safety net and setting a floor on the price of a gilt and a cap on the yield. But that support ended on October 14.
6. What happened to the pound?
Concerns over the September 23 mini-budget also made the pound less attractive to investors – so the value of sterling (the official name of the pound) fell against the dollar.
This meant that it would cost more to import the things we needed from abroad and that would drive up inflation.
The Bank of England is expected to keep inflation at around 2% and it usually does this by making it more expensive for people to borrow money – by raising interest rates to encourage people to save instead of spend.
7. Why has all this affected mortgage lending?
The Bank of England hasn’t raised interest rates since the mini budget, but High Street banks believe it will have to – one of the reasons mortgage rates are rising.
In addition, High Street banks raise money in the markets, which they then lend to customers in the form of mortgages and other loans, but they must offer investors higher interest rates than the government because they are considered riskier investments.
This affects the interest rates banks charge us – so when it costs the government more to borrow money, it makes our mortgages and other bank loans more expensive.
8. So where are we now?
With the Bank of England’s promise to buy gilts ending on October 14, the government needed to act to reassure the markets that it would not borrow too much money to avoid the whole cycle starting over again.
Chancellor Jeremy Hunt has reversed nearly all of the tax cuts announced in the mini-budget and says help for citizens with energy bills will be more limited. From now on, all eyes will be on what happens to gilts and sterling – and, therefore, to our mortgages and bank loans.
Graphics by Zoe Bartholomew and Gerry Fletcher