Inflationary pressure persists, UK has a headache about the "health" of the economy

Financial markets have reacted negatively to Britain's poor economic outlook as the country faces persistent inflationary pressures amid rising wages and no growth in economic output since July 2022.

Financial market traders have abandoned UK government bonds, sending two-year borrowing costs above the crisis-era record of Liz Truss's brief tenure as prime minister in 2022.

Bank of England (BoE) Governor Andrew Bailey has had to reassess the bank’s forecasting process after admitting it would “take longer than expected” to reduce inflation. Faced with average real wages no higher than in 2005 and soaring mortgage costs, households are not satisfied with the government’s claim that the economy has avoided recession.

All this is happening ahead of a general election due next year, which former top Treasury official Nick Macpherson said means the government will be facing voters at a time when interest rates are rising and the economic measures needed to tackle inflation are needed.

The head of the Peterson Institute in Washington, Adam Posen, went even further, arguing that compared to the US and the Eurozone, the UK is burdened with the additional problems of Brexit, the loss of credibility in economic governance, and the legacy of underinvestment in public health and transport services.

These are signs that inflation in the UK will be higher for longer than in most other advanced economies on both sides of the Atlantic, Mr Posen said.

Core inflation in the UK rose from 6.2% in March 2023 to 6.8% in April 2023, unlike more stable rates in the Eurozone and the US. (Source: EPA)

Difficulty on top of difficulty

British finance minister Jeremy Hunt dismissed claims of a “recession” on June 12, but was forced to address inflationary pressures a few days later. He said the government understood the impact on household budgets and the best he could do was “to support the BoE in its efforts to reduce inflation.”

Mr Hunt may have reason to be unhappy with the reaction of the markets and the media, as the UK, the US and the Eurozone are facing economic difficulties. After keeping interest rates at 5-5.25%, US Federal Reserve Chairman Jerome Powell admitted on June 14 that the country's inflation was still not resolved, signaling that the central bank would need to raise interest rates two more times.

Mr. Powell said the Fed still needs to see “credible evidence that inflation is peaking and then starting to decline.”

European Central Bank (ECB) President Christine Lagarde also warned that inflation would stay "very high for a very long time" across the Eurozone as the ECB raised interest rates for the eighth time in a row and issued new forecasts showing higher inflation and slower growth than previously expected.

General economic problems are therefore common, but financial markets have dismissed the UK as largely believing it has more serious problems than other countries.

Figures showed core inflation in the UK rose from 6.2% in March 2023 to 6.8% in April 2023, unlike more stable rates in the Eurozone and the US.

Wage figures released in the week of mid-June showed average earnings rose at a near-record pace of 7.2% in the February-April 2023 period compared to the same period a year earlier.

Business analysts expect the BoE to tighten monetary policy further as wage growth is out of step with its 2% inflation target. Britain's official interest rate is forecast to peak at close to 6% on June 16, after hitting a low of 4.5% in early May.

There are differing views on why the UK's situation has worsened and the financial market reaction has been stronger than in most other economies, even though all economies face the same problems.

One view is that Britain is worse off than any other country on either side of the Atlantic. Like the US, the UK is suffering from labour shortages due to high demand, while like the rest of Europe it is also suffering from high energy prices due to the Russia-Ukraine conflict.

Financial markets and many economists say more is needed to explain the continued rapid wage growth and the gloomy outlook as the energy price shock begins to ease.

Economists say the market's overreaction to this week's data is partly due to growing doubts about the BoE's wage-setting process, its handling of inflation and the government's lack of a convincing strategy to boost growth and productivity in the long term.

Governor Bailey was recently forced to admit to parliament that the BoE’s forecasting models had recently been ineffective, forcing members of the Monetary Policy Committee to use guesswork when setting interest rates. Under pressure to explain these flaws, the BoE has rushed to announce a review of the bank’s forecasting process, acknowledging concerns about the communication of its policy decisions.

Simon French, chief economist at investment bank Panmure Gordon, said the BoE had managed to build a reputation for competence in this area in recent quarters. However, a problem arose from the BoE’s approach of relying on government policies that were publicly announced at a time when they were widely perceived to lack credibility, and where the government could spend more or tax less.

The challenge is getting more serious

There are two deeper problems. First, rapid wage growth has led the public to believe that inflation will stay higher for longer and to seek to protect its interests. Second, despite trying to rebuild its credibility with markets after the turmoil of last autumn, Rishi Sunak’s government has failed to convince investors that it can pull the economy out of its long-term slump.

Data this week showed that, although Britain has so far avoided recession, output is no higher than it was in October 2010 while household incomes have remained unchanged since 2005. With more people working, much of the economy is not growing and productivity is falling, said James Smith, director of research at the Resolution Foundation.

Minister Hunt last week affirmed the government's commitment to boosting productivity in both the public and private sectors to avoid the low-growth trap.

However, a trade report published by the Resolution Foundation on June 15 underscores the severity of the challenges facing the UK, saying the most productive parts of the country’s manufacturing sector will decline unless the government radically rethinks its trade arrangements with the EU.

Despite the measures announced in Mr Hunt’s March budget – including an expansion of state-funded childcare to support working parents – investors “are still waiting for a credible supply strategy”, said Andrew Goodwin, an economist at consultancy Oxford Economics.

Without this strategy, as recent data show, any growth is inflationary, according to Mr Goodwin.

This is clear. If the UK economy can barely grow without overheating, the BoE will be forced to inflict more pain on households in the form of job losses and higher mortgage costs to keep inflation in check. The first indication of the BoE’s stance will come on June 22.

Almost all economists predict the BoE will raise rates by 0.25 percentage points to 4.75%, saying economic data has made it unnecessary for the bank to see more persistent price pressures before raising rates.

Economists at BNP Paribas said that while previously there might have been concerns about raising interest rates above 5% because of the “excessive” impact on homeowners, the Monetary Policy Committee was now ready to make a decision.

Some economists reject the argument that Britain is experiencing more inflation and insist that deflation will simply slow. Swati Dhingra, a member of the BoE’s Monetary Policy Committee (MPC) who has opposed further tightening, warned this week that it could take longer to see the impact of rising interest rates as fixed-rate mortgages become more popular.

Still, higher borrowing costs “have started to put more ongoing pressure on families renting or negotiating in the mortgage market” and wage growth is also likely to slow soon.

However, such warning voices have become rarer over the past month as evidence of the UK's stagflation problems has mounted.

While the figures may improve - making Britain's problems look less dire, most MPC members are ready to deliver a tough message that the Commission needs to step on the brakes even harder because it cannot allow wages and prices to push each other higher.

Source: https://baoquocte.vn/ap-luc-lam-phat-keo-dai-anh-dau-dau-ve-suc-khoe-cua-nen-kinh-te-231584.html