Wait, Does The UK Now Want To ‘Force’ A Recession?

The latest media buzzphrase is to describe inflation as “sticky”, after expectations were dashed that Britain’s cost-of-living may finally be under control. But the relatively benign phrasing masks a more treacherous path the UK economy may be about to tread – and one that may lead to a recession.

What’s happened?

On Wednesday, official data showed inflation defied expectations that it would slow and held at 8.7% in May – making Britain’s rate of inflation the highest of any major economy once again. Expectations were that the rate would fall to 8.4 per cent – still way above the Bank of England’s 2% target.

And there was more. the “core” rate of inflation that excludes volatile items, such as energy and food, took investors by surprise by accelerating for a second month in a row in May, hitting 7.1 per cent, up from 6.8 per cent in April.

Following the release, analysts predicted the Bank of England will raise interest rates again on Thursday for the 13th month in a row – the only question is whether it’s by 0.25 percentage points, or a symbolic half percentage point to 5%.

Why do interest rates matter?

Raising and lowering interest rates is the blunt instrument used by central banks to control prices.

Hiking the “base” rate increases the cost of borrowing, making both credit and investment more expensive. The idea is to put the brakes on spending, thereby curbing the soaring cost of goods and services, or inflation.

But the tried and tested formula doesn’t seem to be working. The Bank is pulling the levers, and making things more expensive, but people are finding the money to carry on spending.

This may be explained in part by the factors driving inflation: last year it was the impact on energy prices of Russia’s invasion of Ukraine, which appear to be coming down. Now it’s wages rising that’s causing the “stickiness”.

So what now? ‘Create a recession’, apparently 

An economist who advises chancellor Jeremy Hunt has warned the Bank of England must “create a recession” to curb inflation – and it can only really do this by continuing to raise rates until people actually stop spending money, despite the misery for mortgage holders and business. 

JP Morgan’s Karen Ward, who is also a member of Hunt’s economic advisory council, voiced concerns over a price-wage spiral –  where companies hike prices and as a result workers demand pay rises, which leads to companies hiking prices again.

She said: “They have to create uncertainty and frailty, because it’s only when companies feel nervous about the future that they will think ‘Well, maybe I won’t put through that price rise’, or workers, when they’re a little bit less confident about their job, think ‘Oh, I won’t push my boss for that higher pay’.”

It comes as the i reports prime minister Rishi Sunak and Hunt have accepted that “lowering inflation must come before economic growth”, and the PM is expected to say on Thursday that he feels a “deep moral responsibility” to grasp inflation by the nettle and that it’s his “number one priority”.

Hang on, isn’t a recession worse?

The big fear is inflation becomes “embedded” – keeping a near constant pressure on household budgets – and the argument is that a short period of subdued economic activity is a better alternative if it fixes this problem.

A recession is defined by two successive quarters of falling economic output – measured by gross domestic product (GDP), which attempts to summarise all the activity of companies, governments and individuals in an economy in a single figure.

Recessions ultimately have an impact on living standards, but the full effect largely depends on how “deep” a contraction is – determining the scale of unemployment and how long it takes for businesses and the jobs market to recover.

The UK has been teetering on the brink of an economic downturn since emerging from the pandemic and being hit by the war in Ukraine, and to tip it over seems counter-intuitive. But to get on top of inflation, crashing the economy appears to be a last resort the Sunak administration is flirting with.

Just don’t expect many politicians to put it so bluntly, if they nod to it at all – it’s going to be incredibly hard to sell this to the public, especially in the run-up to next year’s general election. So, over to the Bank of England …