As festive the season is approaching, economic vigor is weak. Household incomes are falling due to skyrocketing electricity bills. Rising interest rates are shrinking mortgage lenders and straining public finances. Taxes are rising. Office for Budget Responsibility (abr), a fiscal watchdog, predicts the sharpest drop in living standards in history. November 22 OECD, a club of mostly rich countries, predicted that in the next two years, only the Russian economy will be worse among the G20 countries. The Bank of England considers a recession it has already started. Could anything lighten the gloom?
One hope is that interest rates are rising more slowly than previously feared. If abr and the bank made their predictions, both assumed that rates would follow the path that investors were taking – in abrInterest rate expectations rose sharply around the world during the autumn (with Britain briefly rising above 6% due to a disastrous mini budget). Plugged into economic models, high stakes produce dire results. The abrIn the forecast released on November 17, projected interest costs on debt increased more than ever before (see chart). The Bank of England predicted that the recession would cause inflation to fall below its 2% target by 2024.
But the bank sets the rates, not the investors. His prediction was a signal that the markets were too hawkish. Of course, the expected peak rate has since fallen to 4.6%. Lower rates mean cheaper loans and more growth. Had abr measured expectations are closer to when the forecast was published, with the government’s finances looking £10bn better in the 2027-28 financial year, a 0.3% improvement GDP. The abrA rule of thumb is that a one percentage point drop in long-term and short-term interest rates will increase GDP by 0.4%.
NatWest Bank’s Imogen Bakra warns that investors have largely lived up to their expectations of a sharp rise in rates this year. Their predictions are based in part on the observation that the labor market has so far been fairly resilient to rising interest rates, and so monetary policy needs to be aggressive to stem inflation. If rates don’t rise as fast as investors expect, that’s not necessarily good news. Kamakshya Trivedi of Goldman Sachs, another bank, notes that such a scenario likely implies weaker demand than expected.
The best surprise would be one that lowers inflation while allowing the economy to produce more. Easier trade relations with EU or lower global energy prices could achieve this. The latter seems more likely to reduce pressure on household incomes and help public finances by reducing the cost of public support. This would also help growth. The abr believes that for every 10% drop in energy prices, potential production can increase by 0.2%. Therefore, optimists should carefully study the energy markets. And try to forget that what can go down can also go up. ■
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