In the 1970s, as the UK contended with high inflation, low growth and industrial strife, it became known as “the sick man of Europe”. “Britain is a tragedy,” observed the then US secretary of state, Henry Kissinger, in 1975. “It has sunk to begging, borrowing, stealing until North Sea oil comes in.”
Today, Britain is once more an outlier. It has the highest inflation rate in the G7 (8.7 per cent) and one of the lowest growth rates (0.1 per cent in the most recent quarter). In other words, the grim phenomenon known as “stagflation” has returned.
As a consequence, the Bank of England is facing the biggest threat to its reputation since it became independent in 1997. Having initially labelled inflation a “transitory” phenomenon, it has raised interest rates to 5 per cent – the highest level since April 2008. Markets now anticipate a peak of 6.25 per cent – a rate regarded as unthinkable in the decade of cheap money. And as Andrew Bailey, the Bank’s governor, has pleaded with workers not to demand inflation-level pay rises he has lost credibility.
There are legitimate criticisms to be made of Threadneedle Street. As Ed Conway, the economics editor of Sky News, writes for the New Statesman this week, the Bank was far too complacent about the threat of post-pandemic inflation. By continuing to print new money through quantitative easing until the end of 2021, it was “pushing the accelerator even as it should have been easing off” – and later its forecasting models continued to underestimate price rises. The greater risk now, however, is of over-correction.
Andy Haldane, the Bank’s former chief economist, is among the few who can claim to be vindicated. In June 2021, he warned in a prescient New Statesman essay of the return of “the beast of inflation” and voted to reduce the Bank’s planned bond purchases by £50bn. Had his words been heeded, the UK’s inflation problem would now be less severe. In a recent interview with the New Statesman’s Anoosh Chakelian, Mr Haldane called for the Bank to “press pause” on interest rate rises – a demand he has since repeated.
His argument is a persuasive one: raising interest rates before the effects of previous rises are properly known risks triggering an avoidable recession. The prevalence of fixed-rate mortgages means that the majority of households have yet to feel the shock of monetary austerity.
But there are already warning signs. Figures from the Bank of England show that households withdrew a net £4.6bn from banks and building societies in May, the highest level since monthly data began in October 1997. Though savings may help sustain growth in the short term, they cannot do so indefinitely. As well as contending with high inflation, 800,000 households due to remortgage will pay an average of £2,900 a year more because of higher interest rates. Meanwhile, tax rises will cost the average household £4,200 by the start of 2025. Frozen income tax thresholds mean that almost 5.6 million people – or one in six taxpayers – will pay the 40p rate this year.
[See also: Is the Bank of England raising interest rates too far?]
Rather than tightening the squeeze yet further, the Bank should wait until the consequences of its actions are clearer. This could mean tolerating inflation above the target level of 2 per cent for a longer period. But it may prove a necessary choice to avoid much greater economic instability and to protect jobs.
The roots of the UK’s inflation problem are far deeper than excessively loose monetary policy, however. They include Brexit and the trade barriers it has imposed, an over-reliance on energy imports, and “greedflation” or corporate profiteering (a trend now recognised by the IMF).
For more than a decade, politicians counted on low inflation and low interest rates to mask the structural flaws of the British economy. Even as real wages stagnated, households felt better off as cheap credit allowed them to climb the property ladder, and cheap goods from China bolstered their spending power. But the illusion of prosperity is now over.
As politicians struggle to adjust to this reality, the Bank of England has become a convenient target. In this fraught context, further rate rises are an understandable response. But the Bank should first make sure that the cure is not worse than the disease.
[See also: The scourge of greedflation]
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This article appears in the 05 Jul 2023 issue of the New Statesman, Broke Britannia