Explainer: Next British leader to inherit an economy in a bind

0

Sign up now for FREE unlimited access to Reuters.com

LONDON, September 2 (Reuters) – Britain’s next prime minister – to be announced on Monday – will inherit an economy expected to enter a protracted recession later this year, with inflation at a 40-year high and limited options for will restart growth.

Below is a summary of the main issues facing either Liz Truss, the British Foreign Secretary who is seen as the favorite for the keys to Downing Street, or her rival in the race for the Conservative Party leadership, former Finance Secretary Rishi Sunak.

INFLATION

At 10.1% in July, the UK had the highest annual inflation rate among the advanced economies in the Group of Seven. Forecasts say inflation will be higher in the UK, with Goldman Sachs saying it could top 20% if gas prices don’t fall.

Sign up now for FREE unlimited access to Reuters.com

High reliance on imported gas and a rapidly weakening currency explain much of the strength in UK inflation.

In the last three months alone, the pound is down almost 8% against the dollar – underperforming the euro or even the Japanese yen – making energy imports even more expensive at dollar prices.

TIGHT LABOR MARKET

The Bank of England is also concerned about domestically generated inflationary pressures stemming from a tight labor market, where staff shortages in the wake of Brexit and the COVID-19 pandemic are driving wages, in some cases sharply.

Official data shows 188,000 fewer EU workers in the UK than two years ago, while the number of people classified as inactive due to long-term illness rose to a 19-year high of 2.39 million in June, up from about 300,000 since before pandemic corresponds.

However, there are some signs of a slowdown in labor demand. Job vacancies, which hit a record high of 1.3 million in April, began falling, while the number of jobless rose in June for the first time in 17 months.

TAX CUTS? SPENDING RULES?

Truss has pledged to cut taxes, beginning with a rollback of an increase in Social Security contributions and a suspension of so-called green taxes on utility bills. Economists have warned that a large injection of cash into consumers’ pockets could exacerbate Britain’s inflation problem. Sunak proposes targeted support for low-income households through increased social spending, an idea Truss initially dismissed as “handouts” but has recently embraced.

Alongside the risk of fueling inflation, tax cuts for higher spending would further weigh on the UK budget deficit at a time when public debt is close to 100% of GDP.

NO BAILING OF THE BANK OF ENGLAND

Normally, a central bank forecasting a recession would cut interest rates, but the BoE has other concerns, most notably the risk that the inflation surge will create a wage-price spiral that could weigh on the economy for years. Markets expect the BoE to hike interest rates from the current 1.75% to over 4% next year. Most economists see a lower peak. The BoE also plans to start selling some of the bonds it has bought since the 2007-08 global financial crisis, in another form of monetary tightening.

Sign up now for FREE unlimited access to Reuters.com

Writing by William Schomberg and Andy Bruce, Editing by Angus MacSwan

Our standards: The Thomson Reuters Trust Principles.

Share.

Comments are closed.