Rising energy and food prices signal more pain for the UK

Cormorant Oil Field in the North Sea.

A five-quarter recession and inflation surging to over 13% is stagflation on steroids. Given that these are so much worse than the forecasts we have seen from other central banks, is the BoE just showing that the UK is the biggest victim of the surge in energy and food prices? Or is it showing refreshing honesty about the scale of the difficulty that lies ahead which other central banks, so far at least, refuse to admit?

BoE forecasts show a five-quarter recession starting in Q4 of this year with GDP declining by 1.5% next year. At the same time, inflation peaks at 13.3% this year and is still 5.5% on a Q4 to Q4 basis next year. Compare these to the Fed which has a median forecast for GDP at 1.7% next year and PCE inflation at 2.6%. Or the ECB that has inflation falling to 3.5% next year and the economy growing by 2.1%.

Now these Fed and ECB forecasts were done in June and the next set could see the pair catch up to the BoE’s pessimism. For instance, the BoE’s May forecast was already showing the economy contracting 0.25% in 2023. In essence, the BoE’s been forecasting stagflation while others have refused to follow suit. Is this because they are seeking to hide the true awfulness of the situation, or that the UK is simply in a far more difficult position?

Mr. Steve Barrow, Head of Standard Bank G10 Strategy suspects that there’s a bit of both. For instance, the BoE’s calculations suggest that the surge in gas prices will add a peak 6.5% points to CPI inflation, which is almost half the 13.3% peak. That’s certainly way above anything that’s likely to happen in the US and may well be quite large in European terms as well.  In addition, the UK seems to be experiencing greater militancy which could raise wages more in the UK than the US and so ingrain high inflation to a greater extent.

“The same could be happening when we compare the UK with the rest of Europe although it is still early days and we suspect that pressure will increase across the euro zone. The UK also has the added dimension of Brexit. While some would see this as freeing up the UK to enjoy stronger economic performance, through forging its own trade deals, for instance, most disagree. We see it as exacerbating the problems of high inflation as the prices of imported goods are lifted by the increased costs associated with new border regimes, and wages are lifted as EU workers prove more reticent to come to the UK”, said Mr. Steve Barrow.   

But the differences between the UK and many other countries that could make the BoE’s pessimism unique, there is far more that is common to these countries than uncommon. Global economic and inflation cycles tend to be very well harmonised and a lot of the difficulties that the UK is experiencing, such as global supply chain pressures, tight labour markets and more are common to many countries. It might be the case that the BoE is simply too pessimistic while others are right to expect continued growth and a faster moderation in inflation. Generally, most private sector forecasts would concur with this. Mr. Steve Barrow thinks the Bank’s “honesty” in its predictions is not shared by others and these other central banks will be found out in time.  

One final point Mr. Steve Barrow would make is that the BoE still lifted the base rate by 50-bps despite forecasting a five-quarter recession starting in Q4. That’s a salutary reminder to traders and investors that others, such as the Fed and ECB are not going to be scared off from hiking rates because their own economies enter recession - if price pressures are still elevated. With this in mind, he still thinks that these three central banks will lift policy rates by more than the market expects.