UK recessions risks on the rise

 Uk households tighten their belts. Photograph: Yanice Idir/Alamy

The most recent Bloomberg survey of market analysts revealed a median 30% probability of a recession in the UK. However, Mr. Steve Barrow, Head of Standard Bank G10 Strategy, argues that it is at least 50:50. Many other countries face similar risks, particularly in Europe but even in the US as well. The factors pushing economies in this direction are pretty common: supply-chain disturbances, soaring energy and food prices, cost of living pressures as wages fail to match soaring inflation, the prospect of tighter monetary policy, and more. However, Mr. Steve Barrow believes that there are specific risks in the UK for a variety of reasons.

The first of these is that supply chain pressures have been magnified by Brexit. Of course, it is hard to see this clearly given that the pandemic has dominated this discourse, but you only have to look at the UK’s trade performance and the huge queues of trucks at the ports to know that something bad is going on. The total trade deficit, meaning goods and services, has recently doubled on a monthly basis, and we don’t see things improving. The government is scrambling, once again, to delay full border checks on goods moving across the border to the EU.

The checks are due to start in July, but it is thought that this will pose enormous costs on UK firms, particularly smaller ones, and hence the government seems about to try to delay their introduction for a fourth time. In fairness, other countries/regions are being bogged down by weaker trade performances, such as the US and the euro zone, but the UK’s poor performance has the look of greater permanence about it due to the Brexit factor.

Brexit is also compounding the challenging situation in the labour market. Again, many countries around the world are finding labour in tight supply and firms are being forced to push wages up to entice workers. This, in turn, damages their profit margins, increases inflation and puts central banks on alert to tighten even more forcefully, all of which risks tipping economies into recession. The UK’s situation is made much more difficult by the fact that Brexit has stymied labour supply from the EU, not least from low-wage countries in the east of the region.

A third factor is that the UK government has tightened the fiscal screw, something that other countries have been keen to avoid. The 1.25% increase in national insurance from April 1st for those earning above GBP25k hints that the government might be repeating the mistakes of the post-global financial crisis period when it tightened fiscal policy too quickly. If that’s the case again, it looks as if the cost of living crisis that we are seeing across advanced countries, as inflation outstrips wage growth, could be far harsher in the UK because of rising taxes.

Last week, Bank of England Governor Bailey stated that the economy – and BoE policy – is balancing between high inflation and recession. However, the analogy does not seem quite correct, as "falling off" is likely to mean both high inflation and a recession, not one or the other. This does not bode well for UK assets. Stocks have been a bit more attractive internationally in recent years thanks to low valuations compared to peers, but this attraction may be gone now, and perhaps especially so if overseas investors fear a weaker pound as well. That’s certainly something we fear in the near term, as we see sterling/dollar slipping into a 1.20-1.25 range in coming months.