UK economy will need all its resilience in the months ahead, but I think we may squeak by without a recession, says HAMISH MCRAE
Sink or swim?: Is the UK really likely to go into recession?
The Bank of England has woken up at last. For months, the rising danger that inflation might reach double digits has been worrying anyone with any memory of the catastrophic levels it reached in the 1970s and 1980s. You will have read about that here in this column.
But the Bank’s economic forecasters clung to the hope that inflation could be contained. Even as recently as February, the line was that inflation might reach 7 per cent this spring but then would fall back. Now, they have panicked, and about time too.
Last week, the Bank duly increased interest rates to 1 per cent. That was expected. But what shook the financial markets were two warnings. One was that inflation might go above 10 per cent. The other was that the UK economy might go into recession. I think they will probably turn out to be right about the first, but wrong about the second.
To be fair, the Bank of England is far from alone in underestimating inflationary pressure. The Federal Reserve in Washington is realising that it has made a similar mistake, and its half-point increase in rates last week has led to wild gyrations on the markets.
The dollar has shot up – no surprise there – but US equities have been all over the place. First they soared, then they plunged. London markets have been caught in the backwash, with shares off quite a bit and the poor old pound getting clobbered by the Bank of England’s pessimism.
The European Central Bank has yet to come to terms with inflation there, but eventually it too will have to raise rates.
So it was a bumpy week and one that raises a string of questions. My top two are: why did the central banks get it so wrong? And is the UK really likely to go into recession? Economists will argue over the answer to the first for years, but in the spirit of journalism being the first rough draft of history, here goes.
After the banking crash of 2008, the central banks flooded the world with money and brought interest rates down to the floor. That saved the world economy from a really serious recession and was the right thing to do. They expected the policy eventually to result in higher inflation. I remember a very good briefing at the Bank of England setting that out. But it didn’t – or at least there was some inflation in asset prices but not in current prices.
Why so little inflation? Probably a combination of China’s massive manufacturing capacity holding down goods prices and India’s high-tech industries holding down service industry costs. Remember it was the high point of outsourcing. There was also a fair degree of slack in the labour market in most of Europe and the US, which helped hold down wages in the West. The rise in asset prices increased wealth inequalities but that seemed a price worth paying to crank up the economy.
So since the policy seemed to work, when the pandemic struck they did it again. They had been lulled into complacency. But this was a different crisis. It was a shock to the world’s ability to supply goods, not a seizure of the banking system. We could not get the things we wanted to buy, so we bid up the price of everything. As the economy reopened, we bid things up more.
Even ahead of the invasion of Ukraine, supply of everything, including energy, was tight. There was already a huge inflation problem by the autumn of last year, but the war has made it even worse. The complacency has now gone. And when clever people find they have been far too optimistic, their instinct is to make sure they don’t fall into that trap again – hence this warning of possible recession in the UK. It will be a nail-biting time, but I think that will turn out to be wrong for three reasons.
First, many people still have savings, money they could not spend in lockdown. Not everyone is in that fortunate position but in aggregate, consumers are cash-rich and consumption is 65 per cent of the economy. They are also asset rich, thanks to soaring house prices. That gives them confidence. That cash and confidence will support overall demand.
Second the job market is still very strong, with the largest number of unfilled vacancies ever. It will probably weaken a bit, but it will take a long time to do so. And finally, the service-based UK economy has been very good not only in creating jobs, the point above, but shrugging off disruptive blows. It will need all its resilience in the months ahead, but I think we may squeak by without a recession.