Rishi Sunak or Liz Truss? Whoever wins faces a bleak economic outlook | Larry Elliott
BThe weather has a checkered economic past, so it’s not entirely unusual for new prime ministers to take charge in times of crisis. It’s hard, however, to think of a recent prime ministership that started with the dark skies as it is today.
Liz or Rishi? Tax cuts now or later? In a sense, it doesn’t really matter because whoever replaces Boris Johnson will receive one heap of problems.
Harold Wilson took over in 1974 when the country was running three days a week and inflation was rife. Wilson was handed over to Jim Callahan in 1976 when the sterling crisis was about to explode. When Margaret Thatcher defeated Callaghan three years later, it was in the wake of a winter of discontent with soaring inflation.
Liz Truss or Rishi Sunak will have a combination of all of these issues. Inflation is high and rising. Energy bills will rise sharply for the second time this year in October. A summer of strikes has just begun. The British pound is looking weak in the currency markets.
Wilson and Thatcher were at least relieved to know they had a full parliamentary term to make things right. No gear or sonak would have that luxury. And one or more of them will take over mid-term, with standards of living deteriorating and there is little time to make an element of happiness.
The economy isn’t exactly in a recession, at least in a technical sense, experiencing two consecutive quarters of negative growth, but it is showing all the classic signs of heading toward deflation over the coming months.
Retail sales are down nearly 6% year over year. Consumer confidence is at its lowest level in nearly half a century. The latest PMI last week showed manufacturing output contracting and the service sector expanding at its slowest rate since early 2021. PMIs are not a particularly good guide to the exact state of the economy but they do provide some clues to its direction of travel.
None of this is surprising because real wages – price-adjusted wages – are falling at a record pace, and pressure will increase as the annual inflation rate rises from the current 9.4% to around 12% in October.
The Bank of England usually responds to a weak economy by cutting interest rates but this time it will do the opposite. It looks like borrowing costs will rise by half a percentage point to 1.75% when Threadneedle Street’s Monetary Policy Committee announced its latest decision early next month. Interest rates have not risen since the mid-1970s when the economy was in a recession.
The bank is criticized for first fueling inflation and then failing to act quickly enough when price pressures began to emerge. Truss said she wants to take a look at Threadneedle Street’s mandate – the duty to hit the government’s inflation target – to make sure it’s strong enough.
But the bank’s actions need to be contextualised. When the pandemic arrived in early 2020 and the country was shut down, it was appropriate for the bank to cut interest rates and inject money into the economy. At that time, the second great depression was feared.
Likewise, until the Russian invasion of Ukraine, it was reasonable to assume that inflationary pressures would be temporary and the result – mainly – of global factors beyond its control. A year ago, there was concern that the end of the state’s vacation plan would lead to higher unemployment. It wasn’t the case, but the bank didn’t know it.
Vladimir Putin’s actions further hardened the Bank of England. The invasion of Russia was a classic black swan event: something that comes as a shock, has a dramatic effect, and which everyone admits they should have seen coming. It wasn’t just the bank that failed to determine what the Kremlin was planning, but it became unfairly scapegoated.
Attempts to drag the bank into big interest rate hikes are not wise because the economy is in a state of extreme fragility and there is a risk of making the looming recession longer and deeper than it should be. There are signs – particularly from lower commodity prices – that global price pressures are easing, which should lead to a sharp drop in UK inflation next year.
For now, the recession is likely to be short and shallow. This is partly because the unemployment rate is less than 4% and record vacancies mean there are plenty of jobs available. This is partly due to the ability of well-to-do families to live off the excess savings they have accumulated while spending opportunities have been limited during the various lockdowns. This is partly because the real estate market defies gravity and landlords feel less gloomy when home prices are rising.
Obviously, this could change. The demand for labor may fall as activity weakens. Higher interest rates could be the driver of a marked slowdown in the housing market. If people were forced to sell their homes at a discount because they lost their jobs, Britain would return to the negative equity crisis of the early 1990s. For Truss or Sonak, this is the terrifying scenario.
As the Foreign Secretary correctly reminded voters, Britain’s economic performance has been rotting since the Conservative Party’s victory in the 2010 general election. The attacks on the previous Labor government for failing to fix the roof while the sun was shining were more hollow now than it was then, because Britain Not ready for the upcoming test times. Whoever wins the 10 Downing Street race will have the shortest honeymoon.