If 2020-21 was a “virus outbreak” horror film, 2022, so far, is a bad 1970s disaster movie. The typical opening scenario in that genre goes something like this: a problem is detected. There is a failure to recognise the gravity of the threat, which later erupts into a spectacular crisis. In the meantime the whole situation is made much worse with the arrival of numerous new emergencies and calamities.
The initial played-down catastrophe? That was the insistence that inflation was “transient” and would soon go away. The side-plot twists? There have been so many – an illegal invasion and war, strikes over pay, air travel chaos, a government lurching from one (moral) crisis to the next – but the standout, domestically, has to be chancellor Rishi Sunak and health secretary Sajid Javid resigning from the cabinet on the same day, followed the next by (at the time of counting) a further 34 members of government. That makes for two easy predictions for the rest of this year: we'll get a new prime minister and, if Nadhim Zahawi stays as the chancellor, we may get more business-friendly tax policies.
What else can we expect for the remainder of this year, and, after such a difficult first half, are economies and markets slowly but surely sliding into recession and a drawn-out bear phase?
The risk of recession remains high but opinion is divided. While key ingredients are present, some economists argue that an economic downturn is not inevitable and that if it happens, it will be mild. Others view it as unavoidable, given likely further repercussions from the war in Ukraine, inflation, central banks’ tightening actions and collapsing business and consumer confidence.
Inflation has not yet peaked and will continue to creep up. Pressure on energy prices and other commodities will remain elevated unless there is a significant new development, such as the war ending. Meanwhile, in the US and UK, tight labour markets mean other inflationary pressures are likely to build too. In keeping with the disaster movie plot line formula, central banks are by now wide awake to the scale of their predicament, and committed to tough measures even if that causes a recession.
The message now coming from the Bank of England suggests that half-point rises are on the table, ready for deployment if it looks as though inflation is not being brought under control. If the bank sticks to rate rises of 25 basis points for the remainder of this year, the base rate is heading for 3 per cent by March next year. The Federal Reserve has certainly revised its thinking and has pushed defeating inflation ahead of securing a soft landing for the US economy. A second hike of 75 percentage points is expected at its next meeting later this month.
Another factor which could tip the recession balance is that, in the same way we have imported inflation, we could now import a recession if the UK's trading partners get into difficulties. Europe, and Germany in particular, is facing a serious crisis as its supplies of gas are drastically scaled back.
The combination of inflation and rate hikes is also increasing the risk of what analysts call an earnings recession. Business costs in the UK have risen a staggering 22 per cent on average and consumer spending is under pressure from the cost of living crisis – something that will hit home further later in 2022 when we all turn on the heating. Profit warnings, announcements of lower earnings expectations and declining confidence will add to pessimism about markets. Even without a barrage of warnings, the mix of shocks that wiped billions from stock markets in the first half will continue to play havoc with valuations. Value shares should continue to outperform growth.
The forecast is therefore for more turbulence while inflation remains elevated, central banks are in fight mode and war drags on. But if there is one lesson we have been reminded of this year, it’s how quickly conditions (and government cabinets) can change.
rosie.carr@ft.com
