That was enough to drive any voter away. Speaking to Sky News, Jeremy Hunt was asked if he would be comfortable with interest rates so high that the economy would slide into recession.
«Yes,» he said. “Because ultimately inflation is a source of instability. If we want to have prosperity, develop the economy, reduce the risk of a recession, we must support the Bank of England in the difficult decisions they make.”
Such a candid statement is unlikely to play well with pressurized voters in either the Shires or Red Wall, and with the Conservatives still trailing more than 15 points in the polls, it's no wonder it's bad for the back benches as well.
However, the comments make more sense if you understand that neither the voters nor the fractious Tory tribe are the intended target. Instead, Hunt is talking to an excited city.
“Here the game is just to try to calm the markets to make sure we don't get into a situation where they act erratically,” says Andrew. Goodwin, Chief Economist for the UK at Oxford Economics.
“We know from experience what the consequences of this will be after what happened last year.”
The fall of Liz Truss is still overshadows Whitehall. Both ministers and the Bank of England are equally wary of the consequences if the markets decide they want to make a short-term, popular choice without regard to borrowing costs or rising prices.
If Hunt can convince traders that the government is willing to do anything to curb inflation — even at the cost of an economic slowdown — then she will add fuel to troubled waters, believes
«Markets were overly concerned about inflation data this week. The scale at which market prices are moving is significant,” says Goodwin.
Bank representatives are likely to make speeches with a similarly tough stance in the coming weeks, he adds.
The latest turmoil began on Wednesday, when official data showed that prices rose 8.7% in April, well above the Bank's estimate of 8.4%.
Worse, core inflation, which excludes volatile components such as electricity bills and food bills continue to rise, indicating that rising wages are becoming an integral part of the economy and pushing prices up in their own right.
2705 Core inflation continues to rise
This sent borrowing costs skyrocketing and led traders to bet that the Bank would have to raise interest rates by another full percentage point to 5.5% in the coming months.
Such a rate hike may be required to prevent years of rising prices and falling living standards.
However, the risk is that this acts as a brake on growth as consumer spending, investment and hiring slow as a result. City traders are placing their biggest bets on the decline since February.
Under normal circumstances, an economist would say the risk of a recession is 30%, says Neil Shearing, chief group economist at Capital Economics. He now believes the risk is more than double that.
“It's more likely than not. I'd say there's a two-thirds chance,» he says.
The British economy is likely to face a downturn in the second half of this year and early 2024, Shearing said. The housing sector will be hardest hit.
Urban traders have also begun to bet big on the economic downturn.
Under normal conditions, the yield of two-year securities is below the 10-yield year. But this week, that balance has flipped into what's called an inverted yield curve, as a downturn is considered likely in the short term.
«This means the market is now expecting a recession at some point in the future,» he says. Thomas Pugh, British economist at RSM Accountants.
2705 UK risks short-term shock
The inversion gap is the largest recorded since February, when forecasts of a severe recession were widely circulated by institutions such as the Bank and the International Monetary Fund.
The gap is about half the level recorded during the autumn mini-fiscal crisis. .
“You typically expect that the longer you lock up your money, the higher the income to offset this additional risk and inconvenience of being locked up for a longer period,” Pugh says.
“When short-term returns are higher than long-term returns, it means that interest rates or yields will drop quite sharply at some point within two years.”
“And usually you get a drop in returns because you are in a recession. That is why it is commonly used as an indicator.”
This is an independent variable that measures the expectations of urban traders, and not a factor that directly affects the trajectory of GDP.
«It's about the collective wisdom of the bond market anticipating a recession, not how the transition from that yield curve to the real economy is actually happening, which causes a recession,» Shearing says.
But it's clear that the outlook is fast are getting bleaker.
«In February, people expected a recession, but then the economy turned out to be much more resilient than we expected,» says Pugh.
Growth forecast for 2023 (forecast for May) < p>Now the strength of the economy is becoming a problem in itself. The strength of the labor market and rising wages mean that inflationary pressures could become widespread.
Wage growth is currently around 6%, doubling the 3% level that, according to the Bank of England, corresponds to 2%.
p>
Althea Spinozzi, senior fixed income strategist at Saxo Bank, says it may not be possible to set interest rates high enough to curb inflation without hurting this serious damage to banks and the economy.
Bank rate at 5.5% could trigger she says it's a new wave of financial turmoil similar to the one seen in the US in March.
“The financial system showed weakness long before we got to 5%,” she says.
“If rates continue to rise, then it is likely that we may see something else break. There are many problems not only with pension funds, but the problems that we saw in the US can be very relevant not only for the UK, but also for Europe. I believe we will see more of this as rates rise.»
The financial system has adjusted to low interest rates in the 15 years since the financial crisis.
«Financial institutions have taken over a lot of risks based on very low rates. Sensitivity to higher rates is much higher than it was 15 years ago,” adds Spinozzi.
But Bank of England Governor Andrew Bailey is in a quandary.
“The problem is that the Bank will have to choose between inflation or a very, very deep recession,” says Spinozzi.
“If the Bank of England does not contain inflation, there will still be a recession.”< /p>
False for now dawn. Shearing said the latest economic data, such as the Purchasing Managers' Index, suggests that economic performance will bounce back in the next few months.
The real losses will come in six months. But for the Chancellor, this may be a price worth paying to avoid the same fate as Truss.
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