September 30, 2022
World

The U.K. Economy Is in Turmoil, But There Are Signs of Hope

the-uk.-economy-is-in-turmoil,-but-there-are-signs-of-hope

The death of Queen Elizabeth II and the period of national mourning that followed have been the latest blow to Britain’s already struggling economy, but economists and analysts say that there are glimmers of hope.

Britain is at a watershed moment. The country has just completed a 10-day period of mourning, concluding with country-wide shutdowns during a public holiday to mark the late monarch’s funeral. Her death came just two days after a new prime minister, Liz Truss, took office, after the last leader was ousted by his own party for unbecoming behavior, while the U.K. faces a cost-of-living crisis unlike anything the nation has seen in decades. Inflation has soared to the highest levels since the 1980s, at around 10%, and the nation faces an energy crisis due to dwindling Russian energy exports to Europe. The British pound has been languishing around a nearly 37-year low against the dollar. And economic growth is another concern—the U.K. has now fallen behind India, a former British colony, becoming the world’s sixth largest economy. The U.K.’s central bank, the Bank of England, has warned that it risks falling into a recession that could last well into 2024.

The death of Queen Elizabeth II is the latest thing to touch Britain’s psyche. While the monarchy is often viewed as an anachronism, it is still an important part of U.K. life. It’s likely that will continue under the new monarch, King Charles III, who acceded when the Queen passed.

“It really does feel like we’ve entered into a new era for the U.K. as a whole,” says Craig Erlam, a senior market analyst at multi-asset broker OANDA. “That makes for a very interesting time for the country and its place in the world.”

In many ways, the monarch holds a symbolic role, not a political one. That means the change shouldn’t be too controversial, Erlam says. However, it’s a tough act to follow. “She was an incredibly loved figure,” he says. “I just wonder whether there is the same love and devotion for King Charles.”

Britain’s mounting economic pressures When gross domestic product figures for the third quarter are released, it could show that the public holiday for Queen Elizabeth II’s funeral on Sept. 19 slightly depressed growth, pushing the economy into a technical recession of two back-to-back quarters of negative growth, says Steve Clayton, head of equity funds at U.K.-based Hargreaves Lansdown. That’s because of lower productivity and economic output. A similar thing happened in the second quarter, when an additional holiday was granted to celebrate the Queen’s platinum Jubilee, and the economy shrank by 0.1%, according to data provider Trading Economics. “Whatever impact there will be, it will be temporary,” he says. That’s because it won’t likely change any spending on autos, TVs, food, and other things, he says. On top of that, some food banks planned closures on the day of the funeral, meaning those in desperate need may not have been able to get basic necessities.

That’s not to say spending habits haven’t changed. Clayton has noticed a retrenchment in consumer spending, likely prompted by the country’s energy crisis and recent increases in interest rates. U.K. grocery delivery retailer Ocado, which is popular with Britain’s middle class consumers, recently reported that its customers were spending less, sending the company’s shares diving. Clayton says that’s in part also the harsh reality of higher home loan costs.

Many homebuyers use variable-rate mortgages to purchase properties. The Bank of England raised its benchmark lending rate to 1.5% from 0.35% last November. That’s going to have a direct impact on the many U.K. residents with adjustable mortgages. Worse still, the central bank raised the rates by 0.5% today—its seventh successive increase—cutting into many Britons’ household budgets. “That will be painful for those with large flexible-rate mortgages,” Clayton says.

Then there’s the energy crisis, which threatens to plunge half of households into energy poverty. The cost of natural gas in Europe has more than tripled to €217 ($217) per Kilowatt-hour recently from around €70 a year ago, according to data from Trading Economics. The surge occurred because Russia cut its deliveries of natural gas to Europe following the invasion of Ukraine. That price jump directly feeds through to higher electricity prices and heating costs.

Earlier this summer, Britons were warned that energy bills could exceed £6,000 yearly ($6,960) by April 2023, due to higher heating costs this winter. That’s close to 20% of the £31,500 average annual after-tax household income, according to government statistics. Some people will not have the money to pay their bills, experts say.

Warnings have also been given that more than one-in-five U.K. companies with sales above £1 million ($1.16 million,) around 76,000, could face insolvency due to higher energy bills, according to a financial research firm Red Flag Alert. Those with high energy consumption, such as industrial companies, are more at risk.

Liz Truss’s emergency economic relief plans Two days after becoming Prime Minister, Truss announced a cap on household energy bills at an annual rate of around £2,500 for the next two years, with the government paying the difference. The government has also unveiled a £40 billion ($45 billion) plan to help companies, imposing a cap on wholesale energy prices for businesses for six months. Some have criticized such measures as filling the coffers of energy companies that are expected to make bumper profits as a result of rising energy costs.

The U.K.’s new Chancellor of the Exchequer, Kwasi Kwarteng, will announce the government’s urgently needed plan to address the cost of living crisis on Sept. 23. The emergency fiscal event was expected sooner, but was put on hold while Parliament was suspended over the mourning period. The so-called “mini budget” is expected to include tax relief for corporations and individuals and reductions in unnecessary regulations.

“One of the most compelling stories is the U.K.’s economic policy mix,” says Marc Chandler, managing director at Bannockburn Global Forex. Specifically, that means loose fiscal policy (more spending, lower taxes) and tight monetary policy, with higher interest rates. That was the U.S. policy used in the early 1980s, which led to a period of stellar growth.

Chandler also thinks the policy mix will partly help with the country’s other problem: the pound’s falling value. Sterling recently reached its lowest level against the dollar since the mid-1980s. He says the drop in the pound is largely due to the outrageous strength of the dollar. Other rich-country currencies have fallen by similar amounts, notably Europe’s single currency, the euro, and the Japanese yen. Sterling has rarely been as undervalued as it is now, Chandler says, and he expects it could start to rebound once the dollar peaks, which he predicts will be in early 2023.

Truss also wants to ensure a future of stable energy supplies, says Ivo Pezzuto, professor of global economics and digital transformation at the International School of Management in Paris. Higher prices lead to lower demand, but that doesn’t fix the fact that the Kremlin cutting off natural gas deliveries is a supply problem in Europe. “They need more supply,” he says. Gone are the days of building an economy around cheap Russian oil and gas.

Unlike the rest of Europe, Truss’s plan doesn’t mean levying windfall profit taxes on energy companies. She wants to encourage more drilling and has lifted the ban on hydraulic fracturing oil drilling—or fracking. There are also discussions about establishing a robust energy policy that embraces new technology, including nuclear power and renewables. “Some of this will take time before the benefits arrive,” Pezzuto says.

There are other signs of hope for the economy. The unemployment rate, at 3.6%, is the lowest since the 1970s. There are now 1.3 million vacancies versus 1.5 million unemployed people. Put simply, the labor market is tight, which gives employees the power to demand higher wages, which in turn will help offset the rising cost of living. “Employers will be unlikely to hold down wages for long,” says Clayton.

But there’s a caveat to the rising salaries. If the wage demands inflate too much, then the Bank of England may worry about sustained inflation. The result could be aggressively higher interest rates, says Konstantinos Venetis, director of global macro at London-based financial firm TS Lombard. If that happens, the economy could take a hit.

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