This is the week when the inflation thermometer hit 10.1 per cent in the UK, a level not seen for 40 years. Having failed to spot this coming until recently, the Bank of England is now on full alert, warning that the rate will climb even higher, to 13 per cent before the end of the year, and remain at an elevated level through 2023.
But the problems facing the nation are expanding. The extent of the pressure on household incomes is becoming clearer each month through rising prices in the shops, alarming jumps in energy costs (average annual bills are now expected to exceed £5,000) and falls in post-tax real income. The ONS revealed this week that real pay levels are down more than 3 per cent in the quarter to the end of June compared with the same period last year.
To make matters worse, high inflation is likely to impose an unintended dose of austerity on public sector services. The Institute of Fiscal studies has outlined how inflation will squeeze defence, education and health services as promised rises in spending shrink in real terms. To maintain spending at the planned rate would require an additional injection of £8bn in 2023, and £18bn in 2024 and the year after. Not topping up will put public services under even more strain.
Compounding all of this are higher interest rates, the Bank of England's (BoE) main weapon for achieving price stability, which will mean more costly mortgages for anyone buying now or remortgaging, and placing dreams of home ownership further out of reach. Low interest rates have for years kept those dreams alive even as the policy pushed house prices steadily upwards. It's little wonder the words 'social unrest' have been whispered, following suggestions that energy rationing could be adopted during the winter months, and the ongoing lack of clarity on whether another dollop of help is on the way for energy bill payers.
Besides making for an angry electorate, these pressures are tilting us towards the BoE’s predicted recession, which it expects to start in Q4 and to last a year and a quarter in the absence of further fiscal help. Consumer spending is already showing signs of retreating and businesses – particularly smaller ones – are under the cosh of higher costs, pressure to increase wages and declining purchases.
UK GDP growth is sluggish to non-existent currently, melting away in the quarter to the end of June with a decline of 0.1 per cent. That might not seem disastrous but it puts the UK near the bottom of the G7 growth table. In a further sign of a weakening economy, the number of job vacancies fell by 1.5 per cent over the quarter. By 2025 the BoE reckons unemployment will be well over 6 per cent.
While it’s firmly focused on jabbing away at inflation – and no one can doubt that the base rate will be hiked again at the September MPC meeting – politicians don’t fancy the path the BoE is setting out. Tory leader candidate Liz Truss in particular insists that the fate of recession can be averted with a batch of tax cuts estimated at a cost of around £30bn to the state (and which could add fuel to the inflation wildfire).
The UK isn’t alone in this boat – the US has already entered a technical recession. But across the water there is probably more optimism about avoiding a deep economic contraction stemming (possibly prematurely) from recent steadiness in inflation, that nation’s greater control over its energy supplies, strong employment numbers and the passing of a significant piece of legislation – the oddly named Inflation Reduction Act designed to boost investment in green economy and green energy and to collect more tax from the biggest US companies.
Here at home, although a period of economic decline seems inevitable, not all economists believe the downturn will be as deep or as long-lasting as the BoE suggests (see Hermione Taylor on this). And many companies continue to sound upbeat despite the challenges ahead, alongside a number of analysts who believe there is the potential for positive surprises down the line – for more on the earnings outlook, turn to Jemma Slingo’s and Dan Jones’ report.
