Why is Rishi Sunak casting such a sombre mood? It’s more about politics than economics
Rishi Sunak says we are facing a “profound economic crisis”. Big words, not to mention depressing. But do they really stack up?
Is the UK really facing something unique? Can he really blame much of it (as was implicit in his speech) on his predecessor? Or is something else going on?
Let’s start at the start.
There is no doubt that the UK is facing tough economic times right now. We are quite plausibly in the teeth of a recession. Look at measures like the purchasing manager’s index from S&P Global – a measure of how businesses are faring right now – and it is contraction territory. This is a recession warning, and no mistake.
And there are certainly some factors which will make this a grim year or two for households. For one thing, mortgage costs are rising, and rising fast. The average two-year fixed rate mortgage is currently up above 6%, a level which implies the highest repayments as a percentage of household incomes since the late 1980s or early 1990s. This is clearly not good news.
And it’s a similar story for energy bills. Even after you account for the energy price guarantee introduced by Liz Truss, the amount the average household spends on energy this winter will still be the highest we’ve seen since at least the 1950s. Again, not good news – and note that since the scheme has been shortened from two years to six months, it’s quite plausible the costs are even greater next year.
Put it all together and any measure of our collective standard of living suggests an astonishing fall this year. We are all going to be much poorer, relative to what we typically want to spend our money on. And that, in large part, is down to the impact of higher energy prices, which creep into every part of our lives.
But these are not the only issues facing the government.
The UK is not the only major economy facing a potential recession
One problem which no previous prime minister has been able to address successfully is Britain’s productivity malaise. Output per hour is perhaps the single most important yardstick of our economic wellbeing and it has essentially flatlined since the financial crisis, making (and this is not an exaggeration) everything worse: our incomes, our quality of life, the level of taxes and national debt.
And this is before you consider the deeper issues facing the global economy right now. Most glaringly we seem to be in the early stages of a new Cold War, which could result in the creation of trading blocs rather than a fully globalised world. And this prognosis is, frankly, more optimistic than many. This will have enormous economic implications.
But here’s the thing. None of these challenges are necessarily Britain’s alone. The UK is not the only major economy facing a potential recession: others in Europe will probably have even deeper contractions this winter. Disappointing productivity is something many developed economies struggle with. Interest rates are rising everywhere (even if the UK’s recent increase in borrowing costs outpaced other nations).
Many of the current problems pre-date Liz Truss
Nor is it especially fair to blame all these problems on Liz Truss: they pretty much all pre-date her. And here’s the really interesting thing: the spike in government bond yields which followed her and Kwasi Kwarteng’s mini-budget has now been almost completely erased.
Those gilt yields are now nearly back to where they were before. So too are expectations for Bank of England interest rates next year. This is an extraordinary turnaround – a consequence of the fact that the Truss government is no more.
But it means that actually much of the damage has now been erased. It’s worth pondering this for a moment. Remember: that rise in gilt yields as international investors looked askance at the UK pushed up the potential cost of borrowing both for households and for governments. It meant that if the government carried on having to issue debt at those kinds of interest rates then its debt interest bill would have been a lot higher. The IFS calculated the ongoing cost at about £10 billion a year. That’s a big deal.
‘Credibility premium’ on government debt is shrinking
But now that the “credibility premium” on government debt is shrinking, that problem is no longer, well, a problem. It may soon have disappeared altogether.
Which raises a question: why did Rishi Sunak try to cast such a sombre mood on the steps of Downing Street? My suspicion is that it’s about 60% politics and about 40% economics.
The politics first: if he can convince the public (and his MPs) that things are grim, it means less resistance for the inevitable cuts. Much as Covid united the party, perhaps, he thinks, the threat of economic contagion could do something similar.
If he can persuade the public that the bad news he’s meting out is down to Liz Truss rather than his own policies as chancellor (most of these problems were problems when he was in Downing Street and had responsibility for doing something about them) then, well, that would obviously suit him. Even if it’s not entirely accurate.
Sunak’s warnings are only 40% economics
The 40% economics is intriguing, because there’s a virtuous circle here. If he can deploy phrases like “profound economic crisis” and “difficult decisions” he can persuade markets that he’s really serious about cutting debt, which in turn should push down gilt yields even lower. Which means the hole in the public finances suddenly gets smaller too.
Talking tough could actually mean he doesn’t have to act quite so tough in the coming austerity mini-budget or whatever we’ll call it.
Not that much of this will be detectable when the fiscal statement lands. We are clearly in for some tough cuts for the economy. But most of the challenges they are intended to address were baked in long before Liz Truss ever reached Downing Street.
The UK economy grew by 0.1% between July and September, according to the Office for National Statistics (ONS).
However, despite the small positive GDP growth recorded in the third quarter, the economy shrank by 0.1% in September, dragging down overall growth for the quarter.
The growth was also slower than what had been expected by experts and a drop from the 0.5% growth between April and June, the ONS said.
Economists polled by Reuters and the Bank of England had forecast an expansion of 0.2%, slowing from the rapid growth seen over the first half of 2024 when the economy was rebounding from last year’s shallow recession.
And the metric that Labour has said it is most focused on – the GDP per capita, or the economic output divided by the number of people in the country – also fell by 0.1%.
Reacting to the figures, Chancellor of the Exchequer Rachel Reeves said: “Improving economic growth is at the heart of everything I am seeking to achieve, which is why I am not satisfied with these numbers,” she said in response to the figures.
“At my budget, I took the difficult choices to fix the foundations and stabilise our public finances.
“Now we are going to deliver growth through investment and reform to create more jobs and more money in people’s pockets, get the NHS back on its feet, rebuild Britain and secure our borders in a decade of national renewal,” Ms Reeves added.
The sluggish services sector – which makes up the bulk of the British economy – was a particular drag on growth over the past three months. It expanded by 0.1%, cancelling out the 0.8% growth in the construction sector
The UK’s GDP for the the most recent quarter is lower than the 0.7% growth in the US and 0.4% in the Eurozone.
The figures have pushed the UK towards the bottom of the G7 growth table for the third quarter of the year.
It was expected to meet the same 0.2% growth figures reported in Germany and Japan – but fell below that after a slow September.
The pound remained stable following the news, hovering around $1.267. The FTSE 100, meanwhile, opened the day down by 0.4%.
The Bank of England last week predicted that Ms Reeves’s first budget as chancellor will increase inflation by up to half a percentage point over the next two years, contributing to a slower decline in interest rates than previously thought.
Announcing a widely anticipated 0.25 percentage point cut in the base rate to 4.75%, the Bank’s Monetary Policy Committee (MPC) forecast that inflation will return “sustainably” to its target of 2% in the first half of 2027, a year later than at its last meeting.
The Bank’s quarterly report found Ms Reeves’s £70bn package of tax and borrowing measures will place upward pressure on prices, as well as delivering a three-quarter point increase to GDP next year.
Business
Chancellor’s Mansion House speech vows to rip up red tape – saying post-financial crash rules went ‘too far’
Chancellor Rachel Reeves has criticised post-financial crash regulation, saying it has “gone too far” – setting a course for cutting red tape in her first speech to Britain’s most important gathering of financiers and business leaders.
Increased rules on lenders that followed the 2008 crisis have had “unintended consequences”, Ms Reeves will say in her Mansion House address to industry and the City of London’s lord mayor.
“The UK has been regulating for risk, but not regulating for growth,” she will say.
It cannot be taken for granted that the UK will remain a global financial centre, she is expected to add.
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It’s anticipated Ms Reeves will on Thursday announce “growth-focused remits” for financial regulators and next year publish the first strategy for financial services growth and competitiveness.
Rachel Reeves
Bank governor to point out ‘consequences’ of Brexit
Also at the Mansion House dinner the governor of the Bank of England Andrew Bailey will say the UK economy is bigger than we think because we’re not measuring it properly.
A new measure to be used by the Office for National Statistics (ONS) – which will include the value of data – will probably be “worth a per cent or two on GDP”. GDP is a key way of tracking economic growth and counts the value of everything produced.
Brexit has reduced the level of goods coming into the UK, Mr Bailey will also say, and the government must be alert to and welcome opportunities to rebuild relations.
Mr Bailey will caveat he takes no position on “Brexit per se” but does have to point out its consequences.
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Bailey: Inflation expected to rise
In what appears to be a reference to the debate around UK immigration policy, Mr Bailey will also say the UK’s ageing population means there are fewer workers, which should be included in the discussion.
The greying labour force “makes the productivity and investment issue all the more important”.
“I will also say this: when we think about broad policy on labour supply, the economic arguments must feature in the debate,” he’s due to add.
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The exact numbers of people at work are unknown in part due to fewer people answering the phone when the ONS call.
Mr Bailey described this as “a substantial problem”.
He will say: “I do struggle to explain when my fellow [central bank] governors ask me why the British are particularly bad at this. The Bank, alongside other users, including the Treasury, continue to engage with the ONS on efforts to tackle these problems and improve the quality of UK labour market data.”
Business
Reeves has welcome support from Bank’s governor as she goes for growth and seeks to woo City
When Gordon Brown delivered his first Mansion House speech as chancellor he caused a stir by doing so in a lounge suit, rather than the white tie and tails demanded by convention.
Some 27 years later Rachel Reeves is the first chancellor who would have not drawn a second glance had they addressed the City establishment in a dress.
As the first woman in the 800-year history of her office, Ms Reeves’s tenure will be littered with reminders of her significance, but few will be as symbolic as a dinner that is a fixture of the financial calendar.
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Her host at Mansion House, asset manager Alastair King, is the 694th man out of 696 Lord Mayors of London. The other guest speaker, Bank of England governor Andrew Bailey, leads an institution that is yet to be entrusted to a woman.
Ms Reeves’s speech indicates she wants to lean away from convention in policy as well as in person.
By committing to tilting financial regulation in favour of growth rather than risk aversion, she is going against the grain of the post-financial crash environment.
“This sector is the crown jewel in our economy,” she will tell her audience – many of whom will have been central players in the 2007-08 collapse.
Sending a message that they will be less tightly bound in future is not natural territory for a Labour chancellor.
Her motivation may be more practical than political. A tax-and-spend budget that hit business harder than forewarned has put her economic program on notice and she badly needs the growth elements to deliver.
Rachel Reeves on budget day. Pic: PA
Her plans to consolidate local authority pension schemes so they might match the investing power of their Canadian and Australian counterparts is part of the same theme.
Infrastructure investment is central to Reeves’s plan and these steps, universally welcomed, could unlock the private sector funding required to make it happen.
Bank governor frank on Brexit and growth
If the jury is out in a business financial community absorbing £25bn in tax rises, she has welcome support from Mr Bailey.
He is expected to deliver some home truths about the economic inheritance in plainer language than central bankers sometimes manage.
Britain’s growth potential, he says, “is not a good story”. He describes the labour market as “running against us” in the face of an ageing population.
With investment levels “particularly weak by G7 standards”, he will thank the chancellor for the pension reforms intended to unlock capital investment.
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Governor warns inflation expected to rise
He is frank about Brexit too, more so than the chancellor has dared.
While studiously offering no view on the central issue, Mr Bailey says leaving the EU had slowed the UK’s potential for growth, and that the government should “welcome opportunities to rebuild relations”.
There is a more coded warning too about the risks of protectionism, which is perhaps more likely with Donald Trump in the White House.
“Amid threats to economic security, let’s please remember the importance of openness,” the Bank governor will say.
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All that is welcome for Ms Reeves.
Already a groundbreaking chancellor, she is aiming for a political and economic legacy that extends beyond her gender and the dress code.
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