For now, the UK still looks like it’s set to escape a recession, with output in April ticking back up after shrinking in March. With fewer strikes weighing on the public sectors, and consumer spending holding up in sectors like hospitality, it’s helped boost activity.
Gloomier forecasts have been replaced by a brighter outlook. The Bank of England (BoE) and the International Monetary Fund revised their predictions that the economy would shrink this year over at least a six-month period. Consumers have been much more resilient in their spending patterns than expected. Wholesale energy prices have also fallen back, helping relieve company and household budgets.
Is inflation still a problem?
While we look set to avoid recession, sticky inflation is still casting a shadow over the sunnier outlook.
Price rises had been expected to slow much more sharply in April. However, the stubborn nature of inflation, hovering around 8.7%, has led to expectations that the BoE will be forced to hike rates significantly further this year. This could potentially push the base interest rate above 5.5%.
The impact of higher interest rates on the economy
Higher interest rates make borrowing more expensive. So if borrowing costs were raised to this level, it would dent consumer spending power, and lead to lower business investment. This could have the potential to tip the economy back into reverse.
There’s also the risk that more companies could be forced into insolvency if they find it harder to refinance loans they’ve taken out.
Even when the BoE does press pause, immediate cuts in interest rates aren’t expected. That’s because inflation is still likely to be a threat with the ongoing fight for talent across the labour market.
The problems of a tight labour market and the ‘Brexit’ effect
Brexit is considered to have made the problems of a tight labour market more acute, particularly for certain industries, like healthcare. This has had a knock-on effect on another problem facing the economy – the high numbers of long-term sick, given that a lack of staff is likely to mean longer waits for treatment.
With potential workers incapacitated due to illness, there are fewer applicants for vacancies, which is keeping the labour market tight and has led to faster wage growth – only adding fuel to the inflation fire.
The Brexit effect is also showing up in more sluggish export figures compared to other countries in the G7 group of nations, like the US, France, Germany, Italy, Japan and Canada.
What does all this mean and what’s next?
There’s a chance that inflation will fall back much more quickly than the markets expect right now, which may mean interest rates may not have to rise as far as some have forecast. The fall in energy prices feeding through to the inflation reading will help, which could see a softer landing for the economy.
There are also some signs of a turn in the tide afoot when it comes to pay rises with real time pay data indicating the rate of wage growth is beginning to tail off.
Some pre-election giveaways in terms of tax cuts and spending commitments could also boost output.
However, given some of the structural issues still affecting the UK, a big snap back in growth is not expected any time soon.
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