Whoever wins loses: Truss’s successor to inherit grim UK economy
No matter who replaces Liz Truss, the next British prime minister will inherit an economy damned for the immediate future by rising borrowing costs, crippling energy bills, high taxes and no strategy about how to revive growth.
The race is already underway to succeed Truss, who exits Downing Street after her bid to deliver “growth, growth, growth” via unfunded tax cuts for the wealthy spectacularly backfired.
But, just like her, the incoming premier will struggle to craft a plan to rescue the UK from the recession it may already be in or its longer-term limits, no matter what’s said on the campaign trail.
Inflation is in double-digits for the first time in four decades and set to soar further this winter, forcing the Bank of England to keep pushing up interest rates. Even after Truss’s stimulus was reversed via the biggest tax increase since 1993, the Treasury will still struggle with a burgeoning budget deficit, and investors clearly favour restraint.
“It’s very hard to see that the current Conservative Party is capable of delivering anything significant in terms of policy change quite frankly,” said Jonathan Portes, professor of economics and public policy at King’s College London. “In terms of tax and spending, all they can try and do is avoid exploding government credibility again. They will have to play it safe.”
Truss entered office a little more than a month ago, promising to revive the economy with deep tax cuts that seemed to ignore the rapid inflation, and came with no immediate plan for covering them. The ensuing market panic forced her to U-Turn, with the tax burden now back to the highest since World War II.
Most forecasters anticipate a lengthy downturn, exacerbated by a Treasury pivot from focusing on growth to how it will plug what remains a roughly £25 billion hole in the public finances.
What Bloomberg Economics Says …
“Whoever takes over from Truss will still face pressure to balance the books. On the positive side, the gap is smaller than it looked even a few days ago. On the negative, cuts to public spending or increases in tax are always painful and contentious. The next prime minister will be attempting to deliver them with no direct electoral mandate, a Conservative Party in turmoil and markets poised to punish any misstep — no easy task.”
–Jamie Rush, Bloomberg Economics.
Households are struggling with a tightening cost-of-living squeeze, contributing to the government’s sliding popularity. The cost of goods and services is spiraling more quickly than wages, leaving workers with less money to spend.
Bloomberg Economics predicts a 0.4 per cent drop in output next year and says the risks to that lie to the downside. Most economists anticipate no significant growth until the second half of 2023, a little more than a year before the deadline for the next general election. A sliver of hope for Truss’s successor is that early austerity will give room for pre-vote tax cuts.
“The challenges that lay ahead of us are building by the day,” said Shevaun Haviland, director general of the British Chambers of Commerce. “Two-thirds of firms expect to raise their prices and inflation is the top concern. Interest rates are set to climb further in November and energy bills will now rocket again for many in April. This is unsustainable.”
Even beyond the short term, the painful reality is that the factors that drove the UK in the past three decades — cheap goods, labour, credit and energy — are all moving in reverse.
Britain’s economy thrived through the 1990s and early 2000s, along with growing trade with the European Union and Asia, which reduced the cost of goods and services. That along with declining oil and natural gas prices and a free flow of workers from the EU, sent inflation on a downward path until the pandemic, enabling interest rates to drop to historic lows.
Now, all those tailwinds have turned direction. Trade friction with the EU and China, along with global supply chain chaos, have boosted the cost of goods. The war between Russia and Ukraine sapped the flow of natural gas, sending prices soaring.
While unemployment has plunged to the lowest in 48 years, at least 300,000 workers dropped out of the labour force since the pandemic, making it more costly for companies to hire and expand. A million jobs remain unfilled as older people have dropped out of the workforce in droves, and younger ones have stayed in education.
Forced to focus on the inflation shock it was late to spot, the BOE has raised rates to levels not seen since the global financial crisis more than a decade ago. Central bankers led by Governor Andrew Bailey intervened to prop up a gilt market roiled by Truss, but are now turning back to the inflation battle and are likely to tighten monetary policy again next month. Most economists anticipate the first 75 basis point shift in rates since 1989.
Policymakers admit the nation will feel poorer.
“Rises in the relative prices of goods and energy make us collectively worse off,” BoE Deputy Governor Ben Broadbent said in a speech hours before Truss stepped aside. He provided some relief by noting it’s not clear rates need to rise as much as investors expect.
The longer-term malaise is reflected in how the country’s trend growth rate has fallen to just 1.2 per cent from 2.5 per cent before the financial crisis, according to Bloomberg Economics.
That reflects a number of deep-rooted structural problems for the UK since it left the European Union. Low productivity and a deficit of workers make it difficult for the economy to regain altitude after any setback.
The textbook levers for generating some growth — including increased immigration and closer trading ties with Europe — are almost all too toxic for the divided Tory party, whose MPs are unlikely to seek an election before its due date of January 2025.
The UK also lacks the game-changing factors that helped power it out of previous slumps.
Margaret Thatcher had North Sea oil to tap and the Big Bang of deregulation that unleashed the City of London’s financial district. John Major and Tony Blair lured in car manufacturers and investment, including Nissan Motor Co. and BMW AG, while opening the door to foreign workers.
Those tectonic shifts rescued Britain from the 1970s energy shocks and the pound’s collapse in 1992. But now, instead of building new industries, the UK has broken ties with its major trading partner, scaled back links with China and is unlikely to nail a trade deal with the US soon.
“The outlook remains precarious,” said Johan Goltermann, senior markets economist at Capital Economics. “UK policymakers face a series of difficult trade-offs.”