Rishi Sunak or Liz Truss? Whoever wins faces bleak economic outlook | Larry Elliot
Britain has a turbulent economic past, so it is not uncommon for new prime ministers to take over in times of crisis. It’s hard, however, to think of a prime minister in recent times who started out with skies as dark as they are today.
Liz or Rishi? Tax cuts now or later? In a sense, it doesn’t really matter because whoever succeeds Boris Johnson will be handed a bunch of trouble.
Harold Wilson took the reins in 1974 when the country was on a three-day week and inflation was high. Wilson handed over to Jim Callaghan in 1976 just as a sterling crisis was about to erupt. When Margaret Thatcher defeated Callaghan three years later, it was in the aftermath of a winter of discontent and rising inflation.
Truss or Sunak will face a mixture 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 only just begun. The British pound looks vulnerable in the currency markets.
Wilson and Thatcher at least had the comfort of knowing they had a full parliamentary mandate to fix things. Truss or Sunak won’t have that luxury. One or the other of them will take over in the medium term, with a standard of living that will collapse and little time to transmit a factor of well-being.
The economy is not exactly in recession, at least in the technical sense of experiencing two successive quarters of negative growth, but is showing all the classic signs of a slowdown in the months ahead.
Retail sales are down almost 6% year on year. Consumer confidence is at its lowest for nearly half a century. The latest Purchasing Managers’ Index from last week showed manufacturing output contracting and the services sector growing at its slowest pace since the start of 2021. PMIs aren’t a very good guide to the precise state of the economy, but they provide some clues as to its direction. Of travel.
None of this comes as a surprise as real wages – price-adjusted wages – are falling at a record pace, and the squeeze will deepen as the annual inflation rate rises from its current level of 9.4 % to about 12% in October.
Usually, the Bank of England would react to a weaker economy by cutting interest rates, but it will do the opposite this time. Borrowing costs are expected to rise by half a percentage point to 1.75% when the Threadneedle Street monetary policy committee announces its latest decision early next month. Not since the mid-1970s have interest rates increased when the economy was in recession.
The Bank is being criticized for first stoking inflation and then failing to act quickly enough when price pressures began to surface. Truss said she wanted to review Threadneedle Street’s mandate – the government’s duty to meet the inflation target – to ensure it is tough enough.
But the Bank’s actions must be put into context. When the pandemic arrived in early 2020 and the country was locked down, it was right for the Bank to cut interest rates and pump money into the economy. At the time, there were fears of a second Great Depression.
Likewise, until the Russian invasion of Ukraine, it was reasonable to assume that inflationary pressures would be temporary and the result – primarily – of global factors beyond its control. A year ago, there were fears that the end of the government’s furlough scheme could lead to higher unemployment. This was not the case, but the Bank must not know.
Vladimir Putin’s actions have led the Bank of England to become more hawkish. The invasion of Russia was a classic “black swan” event: something that comes as a shock, has dramatic impact, and which, in retrospect, everyone agrees they should have seen coming. The Bank was not alone in not spotting what the Kremlin was planning and is being unfairly scapegoated.
Attempts to drag the Bank into aggressive interest rate hikes are reckless as the economy is in an extremely fragile state and there is a risk of making the impending recession longer and deeper than necessary. There are signs – particularly from falling commodity prices – that global price pressures are easing, which should translate into a sharp decline in UK inflation this year. next.
For now, the recession may be short and shallow. This is partly because unemployment is below 4% and record vacancies mean there are plenty of jobs available. This is partly because wealthier households can live off the excess savings they have accumulated when spending opportunities were limited during the various lockdowns. That’s partly because the real estate market has defied gravity, and homeowners feel less gloomy when house prices rise.
Clearly, that could change. Demand for labor could fall as activity weakens. Rising interest rates could be the trigger for a sharp slowdown in the housing market. If people are forced to sell their houses at a discount because they have lost their jobs, then Britain will be back in the negative equity crisis of the early 1990s. For Truss or Sunak, that is the scenario nightmarish.
As the Foreign Secretary correctly reminded voters, Britain’s economic performance has been rotten since the Tories won the 2010 general election. Attacks on the previous Labor government for not fixing the roof as the sun shone ring even more hollow now than they did then, as Britain is ill-prepared for the hard times ahead. Whoever wins the race for 10 Downing Street will have the shortest honeymoon.