Over the following months, Mr Sunak would begin to make his irritation at Mr Johnson’s high spending known to colleagues, in polite but pointed remarks. The National Insurance rise, announced in September 2021, was a necessary evil to fund Mr Johnson’s insistence on a £12 billion a year increase in NHS funding and a new social care model, Mr Sunak suggested to MPs.
He, however, was increasingly concerned about the prospect of rising prices and whether, if the government continued with its high-spending approach in an “inflationary environment”, it would end up worsening inflation.
At the same time, Andy Haldane, departing chief economist at the Bank of England, publicly warned that the Monetary Policy Committee (MPC) must urgently shift its focus to controlling the cost of living. In a speech on June 30 2021 he warned of high inflation becoming “a central expectation rather than a risk” and said that it was time to “underscore” the Bank’s commitment to keeping inflation at 2 per cent. At this point UK inflation had only just crept up to 2.1 per cent.
Mr Haldane added: “Many borrowers now do not have a rise in borrowing costs in their lived experience, and that increases the chances that it would be not just a surprise, but a rather nastier surprise than we’d planned.”
But Andrew Bailey, the Bank’s governor and chair of the MPC, swiftly rejected his departing chief economist’s analysis – insisting that inflation would only be a temporary problem. “It is important not to overreact to temporarily strong growth and inflation,” he said.
Fears Mr Bailey had got it wrong
One year on, fears were growing in government that Mr Bailey had got it wrong. Inflation had exceeded 8 per cent – five points above the Bank’s target and members of Boris Johnson’s cabinet began privately turning on Mr Bailey.
Discussing the Bank, one of the cabinet ministers said that government figures were “now questioning its independence”, suggesting Mr Sunak should do more to hold Mr Bailey to account. Currently, the only formal consequence for the Bank of missing its 2 per cent target is that Mr Bailey is required to write to the Chancellor explaining why this happened.
Since the Bank’s independence in 1997, successive governments have avoided criticising its approach, and, in response to the cabinet minister’s comments on government discussions, a Treasury source warned that the Bank’s independence was “sacred”.
Mr Sunak’s insistence on avoiding the impression of any criticism of Mr Bailey from the government led to a clear dividing line in last summer’s leadership contest.
Liz Truss generated controversy with her declaration that she would review the Bank’s mandate “to make sure it is tough enough on inflation”.
Mr Sunak resists tax cuts
Mr Sunak categorically rejected such an approach. He also firmly rejected Ms Truss’s plan for tax cuts, saying it would fuel inflation.
As Prime Minister since October, Mr Sunak has maintained both approaches, with the Government relying only on firmly-worded responses to Mr Bailey to express its concern about inflation spiralling out of control and resisting calls for cuts to personal taxes.
Interestingly, in his most recent response to the governor on Thursday, Mr Hunt appeared to adopt stronger language than previously, warning the Bank that the 2 per cent target must apply in both good weather and bad.
“Our commitment to this target is iron-clad and it applies at all times,” Mr Hunt wrote to Mr Bailey on Thursday.
Having pledged at the beginning of the year to halve inflation by the end of 2023 – a change not entirely within his control – Mr Sunak illustrated the extraordinary position in which he now finds himself on Thursday, assuring voters: “I’m 100 per cent on it, it’s going to be okay.”
A No 10 source said last week’s figures showing that the consumer price index measure of inflation remained at 8.7 per cent in the year up to May, “vindicated” Mr Sunak’s decision to focus on halving inflation from more than 10 per cent in January.
‘Rishi has been proven right’
Critics had claimed that the target would be “easy” to meet given forecasts already showed inflation falling to 2.9 per cent. “Rishi didn’t buy any of that in January and certainly doesn’t buy it now. Again [he has been] proven right,” said the source.
Mr Sunak and his team are, however, deeply worried about the persistence of inflation, and the resulting mortgage hikes that have already pushed the average two-year fixed rate to more than 6 per cent.
“It’s very bleak – about as bad as it could be, really,” said one senior minister. “The Bank of England was not alone among central banks but they did fail very considerably.” A growing number of MPs and ministers believe that the extraordinary rise in mortgage rates amounts to the final nail in the coffin for Conservative prospects of winning the next election. “These are our people,” said one Tory source whose own mortgage is up for renewal imminently.
Some government figures, including members of the Cabinet, also fear that Mr Sunak is missing opportunities to win over voters with ambitious policies in the final year before the election. One minister said that No 10 appeared to be blocking many policies, stating: “Where’s the vision? We’re not doing anything.” Privately, some Tory figures concede that voters would be justified in punishing the party for presiding over a housing crisis that most admit the Government has failed to tackle in any meaningful way.
Sombre talks on Wednesday night
Now soaring inflation and mortgage rates appear to be an even more difficult problem to solve. Mr Sunak and Mr Hunt held sombre talks on the issue on Wednesday evening.
The ONS figures “were a surprise”, said a government source. “Market expectations, both internally, and externally, were that it would fall by 0.2 per cent and it remained static.” But both men were “utterly resolute” about the need to continue on their current path, involving rejecting spending and tax-cutting plans that they believe would worsen inflation.
The Prime Minister and Chancellor were already resolved that a mortgage bailout was out of the question.
A Treasury source described calls for a £3 billion mortgage protection fund as “insane”. Similarly, the Prime Minister and Chancellor dismissed Tory MPs’ demands for the return of Margaret Thatcher’s mortgage interest relief at source (Miras) scheme – effectively a tax cut for mortgage holders.
“Miras would be inflationary and… there is a moral hazard where those who don’t have mortgages would be subsidising those who do,” said the Treasury source.
Breathing space to homeowners
Instead, the Prime Minister and Chancellor hatched a plan to ask lenders to give breathing space to homeowners facing a mortgage cliff edge. Mr Hunt effectively bounced bank chief executives into signing up to a plan at a meeting on Friday. Following an initial silence, all of those around the table eventually agreed to the proposals, according to a source.
Now Mr Sunak and Mr Hunt are planning to cite the inflation figures as evidence that they cannot accede to unions’ demands for large pay rises. The pair will also seek to rein in government spending across Whitehall.
“He wants to do the things that are right for the long term,” said an ally of the Prime Minister. This week, No 10 will cite the publication of a long-term workforce plan for the NHS as an example of that approach.
Ultimately, though, if inflation fails to subside, Mr Sunak’s fierce opposition to tax cuts in the absence of a recovery could leave the Conservatives with little in their arsenal to persuade voters that they can bring down costs.
In such a scenario, next year’s Tory election campaign will focus on insisting that Labour’s approach would lead to tens of billions of pounds more borrowing a year and generous public sector pay rises, both of which would fuel inflation.
Put simply, one government source said: “Our message will be, if you think this is bad, you ain’t seen nothing yet.”
