UK recession looms

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Summer recess

England thrashed China 6-1 in the women’s football World Cup yesterday. The day before, England won a moral victory in the Ashes. Tomorrow, almost certainly, interest rates will go up.

So what? It’s a good thing there’s more to life than rates. Otherwise a cheerless summer would be in prospect for Britain’s homeowners, business owners and their prime minister, because they’re on a glide slope to recession.

Unemployment is creeping up. The cost of living crisis is easing but still acute. Rates could rise several times between now and the end of the year, nudging the economy into a recession the chancellor is said to welcome if that’s what it takes to tame inflation.

If it happens this recession is likely to be shallow and wide but uncomfortably long:

shallow – a few quarters of mild contraction unlike the plunges of 2008 and the 2020 Covid crash;
wide – hurting renters as well as homeowners and the service sector as well as manufacturers; and
uncomfortably long – especially for the ruling Conservatives. UK growth could still be negative as their election deadline looms in early 2025.

The IMF’s latest guidance was that Britain would avoid recession, but that was last month. Warning signs flashing since then include:

Sentiment – as measured by the manufacturing PMI (purchasing managers’ index), an important measure of confidence in the sector’s future, which fell yesterday to 45.3, its lowest since mid-2020. Manufacturing accounts for 16 per cent of the UK economy.

Yield curve. Short-dated government bonds are offering higher yields than longer-dated ones, reflecting market expectations that things will get worse before they get better and inverting the yield curve – a sign that has predicted all six US recessions since 1978.

Debt interest. High government borrowing linked to retail price inflation meant the UK paid £9.8 billion in interest payments in April – £3.1 billion more than in April 2022. That’s money it could have invested in public sector organisations, boosting growth.

Core inflation – is down from 7.1 per cent in May (its highest in 31 years) to 6.9 per cent in June, but still more than three times the target level of 2 per cent. As of last month overall UK inflation was still substantially higher at 7.9 per cent than in the EU (5.5) or the US (3).

Politics. Halving inflation is one of Rishi Sunak’s five “immediate priorities”. He’s not close yet, and so must let the Bank of England administer its interest rate medicine or plan for an election without inflation under control.

Liz Truss was right about growth even if she was wrong about everything else. There’s little sign of it in the UK economy and even less now than before yesterday’s manufacturers’ PMI numbers (see above), which work like a self-fulfilling prophecy. “Manufacturers’ expectation of the future is driving reduced activity today,” says Fhaheen Khan of Make UK. “Companies [are] engaging in defensive manoeuvres by cutting jobs and investment to protect the viability of their business.”

All aboard. Where manufacturers lead, others will follow. “Industrial output is already declining,” says Paul Dales of Capital Economics. Next he expects to see households cut spending and businesses cut investment and employment across the economy. “We’re on the cusp of the period where inflation will start to have less impact on people’s economic activity but that will be more than offset by the bigger drag of higher rates.”

Hurt locker. High inflation tends to hit low-income groups hardest. High rates hit those with mortgages. “Most of those two groups are going to be affected,” Dales says. But low-to-middle income owner-occupier households will probably hurt most. Research by the Resolution Foundation finds those in the second, third and fourth poorest deciles will face up to twice the increase in mortgage payments as a share of income as those in richer deciles.

Cheer up. High rates are helping 24-34 year-olds save for deposits and the biggest house price drop in 14 years will bring homes for some within reach. Lenders have even started lowering fixed rates to win back market share.

Then again. South Korea and Slovakia are expected to overtake the UK in GDP per capita as early as next year, per the Sunday Times, and inflation-adjusted disposable incomes won’t return to 2021 levels until 2027.

Go lionesses!

Photograph Christopher Furlong/Getty Images