UK economics: a new leader faces a myriad of challenges
As Britain welcomes new Prime Minister Liz Truss, they have a docket full of the cost-of-living crisis, particularly with the average energy bill set to rise a further 80% in October.
3 minutes to read
Furthermore, rising interest rates and a currency under pressure to name a few, will add to their in-tray.
Higher inflation is inevitable
Inflation has and is continuing to rise across the globe, but the UK is taking the brunt with double digits reached in July, 10.1%. The Bank of England expect a peak of 13% later in 2023, some, such as Citigroup and Goldman Sachs, expect much higher at 18% and 22% respectively, given the recent rise in gas prices and 80% rise in the price cap on energy bills due in October.
However, the new governments two-year cap of £2,500 means this will be a smaller 27% rise and prevents further increases.
Inflation will continue to climb this year, yet with the cap many forecasters expect inflation to peak around 11% and then fall back to an average of 5% in 2023. The new chancellor, Kwasi Kwarteng, is expected to unveil an emergency budget which may offer some further respite such as a reduction in VAT.
However, other potential tax cuts, such as the reversal of National Insurance hike, could end up adding to inflationary pressures as spending will not be as constrained. Either way, forces are in motion for higher inflation in the coming months.
The Bank of England committed to taming
The Bank of England, like its counterparts at the annual gathering of central bankers at Jackson Hole, are committed to tackling inflation. The rhetoric is that it may inflict some economic pain now, but this is to prevent much more hurt if we see the return to 1970s if inflation continued to run riot. Markets are now pricing in a base rate of 4% by the middle of 2023, from 1.75% currently.
There are three decisions remaining in 2022, the next in mid-September has expectations of a 50bps rise to 2.25%. It is likely we will see the base rate at a minimum of 2.5% before the year is over. However, at some point, the Bank will need to assess where it has influence and if the tightening is working in those areas before taking it too far.
Pound set for weakness
The US dollar continues to strengthen this year on the back of the Federal Reserve’s commitment to raise rates.
The pound has seen $1.16 in recent weeks as a response and is unlikely to move significantly even as the BoE hikes rates. Forecasting house Capital Economics now says that it could reach a record-low of $1.105 by mid-2023 as the UK takes a bigger hit to growth that the US.
Dollar denominated buyers and those with currencies linked to the dollar have seen relative buying power increase and this could extend further, particularly as travel bounces back with Heathrow passengers 82% of their 2019 levels in July this year.
We will almost certainly see what many define as a technical recession beginning in the final quarter of 2022 and the Bank of England agrees. The truth is there won’t be clarity on the depth or length until it is over, hindsight is brilliant that way. Given many underlying factors, notwithstanding any sizeable shocks, I believe it will be shallow, something with which KPMG’s Chief Economist, Yael Selfin, agrees.