This week, we take a step back to consider where we are heading in the UK and whether a recession in 2024 is inevitable.
To understand where we’re headed we need to understand how we got here. The most worrying feature is that the UK is the only major country where core inflation has been going up. It started the year at 5.7% and the latest figure is 7.1%. In the US and Europe, core inflation remains too high, but it is headed down (with the odd interruption, as we may see in Eurozone this week).
Core inflation is closely watched by central banks because it is reckoned to be more persistent. And in the UK, rising core inflation has been accompanied by an acceleration in wage inflation. The two together pushed the Bank of England (BoE) to accelerate its base rate hiking strategy.
The strength in UK inflation is directly related to the strength in the UK economy. Despite the cost-of-living crisis and weaknesses in the housing market there are plenty of consumers with money to spend. The UK government spent over 20% of GDP supporting the economy during covid at a time when lockdown meant we couldn’t spend it. The result was an accumulation of cash and reduced debt amounting to well over 10% of income. Of course, lockdown ended well over a year ago but the fear of sky-high energy bills last winter scared consumers into saving even more. Consumer confidence has recovered strongly in the UK since the lows of last autumn and spending has followed suit. This has occurred at a time of ultra low unemployment. As a result, companies had put up their prices and raised wages as they compete to retain and recruit staff.
Adding fuel to the fire was the decision to uprate social security payments and the living wage by 10%, taking effect in April. This has boosted spending and wages. This is a key reason why the UK has bucked the international trend of lower core inflation.
So where do we go from here? The aggressive 0.5% hike by the BoE means that mortgage rates have jumped, approaching 6% for 5-year fixed deal and even higher at shorter maturities or high loan to value ratios. Many consumers, coming off previous fixes at below 2%, are facing a huge rise in mortgage payments. Most of the damage is yet to come.
As the squeeze from higher mortgage payments feeds through, consumers will cut spending. Lower spending means lower profit margins and reduced employment. Consumer incomes will be hit, and spending will fall further meaning a recession in 2024 would seem to be the inevitable result. But wage inflation will slow, and price inflation will follow suit. If that happens then the BoE will have done its job.
The big question is whether the recession will be mild, a ‘softish’ landing or more severe. And the truth is, nobody, including the BoE knows the answer. What is clear however, is that the recent surge in UK wage and price inflation makes a hard landing more likely.