Economy · August 6, 2022

Britain has no good options as the threat of a recession looms

The writer is the author of “Two Hundred Years of Muddling Through: The Surprising Story of the British Economy”

The Bank of England’s new forecasts give an exceptionally bleak reading. In recent months, the bank’s governor, Andrew Bailey, warned that the bank is walking “a narrow path” between the risks of continued high inflation and the possibility of a recession. The UK is now ready to experiment with both, leaving the next prime minister with some awkward choices.

The BoE expects inflation to peak over 13 percent annually and stay above 10 percent for much of 2023. It predicts the economy will slide into recession in the next quarter and not return to growth until 2024. Even then, any recovery will be anemic. Unemployment, in the bank’s central scenario, will increase for each of the next three years.

The BoE predicts that the depth of the recession will be comparable to that of the early 1990s and milder than that following the financial crisis or the freezes associated with the pandemic, but the blow to household incomes will be much deeper. Forecasts show the largest decline in households’ real disposable income in two years.

Yet despite the forecast of a recession, the Monetary Policy Committee recorded a 0.5% rise in interest rates, the largest single increase since the bank gained operational independence in 1997. Although the UK Far from unique among advanced economies when it comes to suffering from high inflation distress, the nature of British inflation is starting to seem more problematic.

European inflation is primarily a story of rising energy prices, while US inflation is now driven by a strained labor market pushing up costs in the services sector. Britain has a dose of both.

The MPC has been content to look mostly beyond above-target inflation driven by rising global commodity prices and pandemic-related supply chain disruptions, but now believes price pressures generated at national level require stronger action. Reducing these internal pressures, according to the MPC, requires painful medicine: higher interest rates to slow hiring decisions and take some of the heat out of the labor market, even as high energy prices already put incomes under pressure and consumer spending.

This point of view is certainly questionable. Cornwall Insight, a consultancy, estimates that the typical household energy bill will be around £ 3,500 in 2023, rising from closer to £ 1,000 in 2021. With consumers forced to spend around 9% of their net income. taxes in 2023, from 4.6 percent before the price hike, discretionary spending on other goods and services will drop dramatically.

Labor-intensive service companies targeting consumers could rethink hiring plans relatively quickly as demand runs out. being dragged to work to make ends meet by increasing the job offer. The rise in energy bills is inflationary in the short term. But in the medium term they act as an increase in deflationary taxes on households and businesses.

But whether the BoE’s predictions are correct or not about how the labor market and domestic price pressures will develop are almost certainly wrong when it comes to how the Treasury will respond. The latest numbers of the bank, as always, are conditioned by the failure to change the fiscal policy. However, once Britain has a new prime minister in early September, some form of fiscal easing will follow in the form of tax cuts, further discounts on the energy bill, or both. It’s hard to see that none of these measures are enough to avoid a recession at this point, but they could still ease some of the pressure on household income in the coming months.

Whoever the next British Prime Minister is, their relationship with the BoE will become increasingly strained. An MPC poised to raise interest rates in a recession forecast is signaling it will move to offset any fiscal easing coming from the government with tighter policy.

The bank concluded that a recession is necessary to bring inflation back to target. Liz Truss, the favorite to win the conservative leadership contest according to both polls and bookmakers, has warned the BoE in recent weeks about its failure to control inflation. You’re unlikely to be particularly happy with a central bank ready to act by raising rates in a slowing economy and offsetting any political easing from a leading government.

In a context of global energy price inflation, a mix of more accommodative fiscal policy and tighter monetary policy may be appropriate for Britain. Targeted tax support can support households most at risk from rising prices and prevent some otherwise profitable businesses from failing. Higher rates can support the value of the pound and help ease the pressures on imported prices.

But picking the right policy mix for Britain is now much like taking the least wrinkled shirt out of the laundry basket – the best option isn’t necessarily the good one. The country is poorer than it thought. In the short term it is inevitable. The real political debate is about how this pain is divided between households, businesses and the government budget, not how it is avoided.