Hiding behind Britain’s political turmoil is an economy on the brink

CNN business

The spectacle surrounding Liz Truss, who on Thursday sealed the fate of the shortest-serving prime minister in UK history, has quickly given way to a frantic race to decide who will replace her. Will it be the former finance minister and his latest opponent, Rishi Sunak? Or his predecessor Boris Johnson, who could make a stunning comeback?

But while the world watches the drama unfold, a grim reality lurks: whoever moves into No. 10 Downing Street next will inherit an economic mess with no easy fix.

The Bank of England believes the country could be in recession, and the economic outlook is expected to get worse before it gets better, as high energy prices push households to cut back on spending.

A government report released on Friday showed retail sales fell 1.4% in September, worse than expected. Sales volumes are lower than before the pandemic. Consumer confidence is near the worst level on record as inflation is at a 40-year high.

At the same time, investor concerns about the UK’s finances, which came under the spotlight during Truss’s tenure, will make it difficult to unveil any stimulus beyond immediate support for the energy bill.

“A key focus for the next prime minister and chancellor-elect must be fiscal responsibility,” Carl Emmerson, deputy director of the Institute for Fiscal Studies, said on Friday. “We need a credible plan to ensure that government debt will come down in the medium term.”

Although a senior Bank of England official indicated this week that investors may be pricing in too many interest rate rises, the central bank is expected to remain aggressive in its campaign to keep prices under control in the short term.

Economists agree that if the UK is not in recession, one is likely to arrive soon. The country’s output contracted by 0.3% in August, after increasing by just 0.1% in July.

Dean Turner, an economist at UBS Wealth Management, called the spending outlook “pretty bleak, to say the least.” The main questions now, he said, are how long the contraction lasts and how deep it is.

The picture of the UK’s financial situation also darkened with the release of new data on Friday, which showed that the British government borrowed 20 billion pounds ($22 billion) in September, 5.2 billion pounds ($5.7 billion) more than the country’s fiscal chief had expected.

“The weakness in retail sales and the overshooting of the Office for Budget Responsibility’s March public borrowing forecast will not make the next prime minister’s task easier to navigate through the cost of the economic crisis, the debt crisis and the credibility crisis,” Ruth Gregory, senior UK economist at Capital Economics, told clients. in a corrected note.

The pound fell 1.4% against the US dollar on the gloomy reports, sinking below $1.11. It may continue to lose ground as the dollar rises.

Truss said the Conservative Party would appoint a new prime minister within a week. Who will be – and who will lead the Treasury under his leadership – investors and economists are hoping to keep in place the renewed economic plan outlined by the current Chancellor of the Exchequer, Jeremy Hunt.

On Monday, Hunt – just days after starting work – announced a rollback of almost all the tax cuts in Truss’ original “growth plan”, which was rejected by investors. Citing a renewed commitment to control the country’s debt, Hunt also said the government would cap energy prices universally until April. Support from then on will cost taxpayers “significantly less than expected,” he added.

“Whoever becomes prime minister, and even if they decide to change the chancellor, it seems to me that the fiscal path is quite shocked because the markets will not accept anything other than what’s on the table,” Turner said.

That could keep financial markets under control for now, although firm guarantees and more details on budget plans would be welcome at a time when bond markets around the world are showing signs of strain, said James Athey, chief investment officer at Abrdn, an asset. the manager

“It keeps the pause button pressed on international investor engagement again,” Athey said.

There is also ambiguity about the Bank of England’s next moves. Ben Broadbent, deputy director of monetary policy, warned on Thursday that investors may have been too early in predicting rate hikes amid the recent turmoil.

“Whether official interest rates need to rise as much as they are currently priced in financial markets remains to be seen,” he said in a speech.

The central bank is still expected to be very dovish at its November and December meetings. If the economy slows significantly in the coming year, it could reverse later. That said, if the government removes some of its energy bill subsidies in April, that could stoke inflationary pressures, again complicating the calculation.

“Let’s be honest, we don’t know what the price of energy will be in April, so we don’t know what the impact will be on household budgets,” Turner said.

This leaves investors guessing for longer, and economists waiting to revise their forecasts.

“Clarity and certainty are unfortunately sorely lacking,” Athey said.