The Bank of England doesn’t need to tell us times are tough.
Even before Thursday’s recession warning, the typical person’s finances were already stretched as prices, particularly food and fuel, soared.
Half of households cut energy use in the spring, while a third reduced spending on groceries and other basic necessities. Our standard of living has reversed, on the largest scale since the 1950s.
But what the bank underscored yesterday was how much worse things are getting – and for a lot longer than previously thought, with warnings that activity across the UK economy will reverse by the end of 2023.
The factors behind it were both largely beyond his control and unpredictable.
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Front and center are these energy bills. By next February, the domestic price cap could be double what it is now – and that is largely due to the aftermath of the war in Ukraine.
We may not source much gas (less than 5% of our supply) from Russia, but this country limiting the amount of gas it pumps to Europe has sounded the alarm and global wholesale prices are rising again.
These energy bills directly account for about half of the increase in our cost of living, with some of the rest reflecting higher global food prices, which are also a result of war.
It is this external source of inflation that is making it difficult for the Bank of England to contain the problem. Its main tool – raising interest rates – works by inducing a slowdown, which allows borrowers to spend less money, giving companies less leeway to raise prices.
Not only is that less effective when the main source of inflation is rising global costs rather than strong demand, but it also means interest rates are compounding the pain.
How much can the state help? Billions of pounds of public money are already pouring into budgets, but even with the additional pledges from those vying for the post of next Prime Minister it will not offset the increase in bills we are facing.
Rishi Sunak’s promised VAT cut on energy bills will only offset part of the price cap increase. Liz Truss’ tax cuts will likely come too late to stave off a recession — and some economists warn they could actually prolong the era of elevated inflation — and thus potentially higher interest rates — by allowing additional spending on non-essentials.
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In terms of the impact on jobs, the main challenge for companies in the short term remains to fill vacancies given the shortage of staff. If the pressure continues, their hiring plans and ability to retain employees may change.
The Bank of England does expect unemployment to rise, but gradually. It is estimated that 800,000 people could lose their jobs in the next few years.
If we’ve learned anything in recent years, it’s that the economic landscape can be largely unpredictable.
But this crisis will burn itself out. Wholesale prices for groceries such as wheat and cooking oils are already stabilizing as Ukraine begins exporting goods again by sea.
At some point, energy prices will stabilise, even fall: the big question is when.
The pressure on household finances caused by higher interest rates will dampen spending in a way that limits other price increases, and interest rates will fall again.
Meanwhile, the next person to move into #10 will have an almighty challenge to overcome, and it doesn’t end there.
Economists, including those from the International Monetary Fund, have highlighted that Britain’s prosperity growth, on average, has lagged many of its peers for several years.
The think tank Resolution points out that this has been accompanied by an increase in inequality. Getting us back on track in the longer term, they argue, will require significant investment and effort to transform us into a more skilled and efficient economy.
The hard work is far from over.
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