The government has scrapped most key elements of its mini-budget after just over two weeks – but why has it had to deal with financial market turmoil? Why does this matter to mortgage payers and everyone else?
1. What has the government done?
The government’s job is to decide how much to spend on the things we need, like the NHS, defence and education, and how to pay for them – it uses taxation and borrowing to pay for it.
The government has announced to help people pay for their energy bills, but the September 23 mini-budget doesn’t say how. In fact, it announced a number of tax cuts – suggesting that borrowing would have to increase or even exceed expectations to make up the difference.
2. How does the government borrow money?
The government borrows money from investors through a type of contract called a bond or gilt – basically it promises to repay the money after a certain period of time and pays the investor a fixed amount each year as a fee.
Yield is a way of describing the amount investors get.
3. Where does the market come from?
The term market refers to investors, and the biggest players — those with the most money, such as investment banks, pension funds and insurance companies — fear the government will have to borrow money to cover its small budgets.
They worry that the government won’t be able to repay the money owed to them, and that the value of the loan will be reduced when it is repaid due to inflation (how much of something goes up in price over time).
Therefore, they are not prepared to buy the gilts at the prices that investors have paid before. It also means the government has to pay higher yields to convince investors to buy new gilts – so it’s more expensive for the government to borrow money.
4. Why are pension funds a problem?
In addition to buying gilts, some pension funds use them as collateral to borrow from banks in order to pay people’s pensions – and they then sell the gilts to give the money back to the banks.
But when the value of the gilts on the small budget fell, the pension fund had to sell more money to raise the same amount to pay off the loan. As more gilts are sold, their value falls further, potentially creating a vicious cycle that leaves some pension funds unable to pay their debts.
5. What did the Bank of England do?
The Bank of England is independent from the government but has instructions to keep the country’s finances stable – something that would be at risk if a number of large pension funds fail.
It stepped in on Sept. 28 and pledged to buy gilts to stop its prices from falling further — effectively acting as a backstop, setting a floor on gilt prices and a ceiling on yields. But that support ended on October 14th.
6. What happened to the pound?
Fears of a small budget on September 23 have also made the pound less attractive to investors – so the pound (the official name for the pound) has fallen in value compared to the dollar.
That means it costs more to import what we need from abroad, and it drives up inflation.
The Bank of England is expected to keep inflation at around 2%, and generally does so by making it more expensive for people to borrow money – raising interest rates to encourage people to save rather than spend.
7. Why does all this affect mortgages?
The Bank of England has not raised rates since the mini-budget, but High Street Bank thinks it must – one of the reasons mortgage rates have risen.
In addition, high street banks raise money from the market and lend it to customers in the form of mortgages and other loans, but they must offer investors higher interest rates than the government because they are seen as riskier investments.
This reflects the interest rates banks charge us – so our mortgages and other bank loans become more expensive when it is more expensive for the government to borrow money.
8. So where are we now?
With the Bank of England’s pledge to buy gilts due on October 14, the government needs to act to reassure the market that it won’t borrow too much to avoid a full cycle restart.
Chancellor Jeremy Hunt has scrapped almost all the tax cuts announced in the small budget and said help for people’s energy bills will be more limited. All eyes will now be on gilts and sterling – and the outcome of our mortgages and bank loans.
Graphics by Zoe Bartholomew and Gerry Fletcher