Rishi Sunak has been warned the UK economy could be in recession next year as stubbornly high inflation pushes interest rates to more than 5% before the next general election.
Setting the stage for a further rise in borrowing costs on mortgages and loans for millions of households, economists predicted the Bank of England could be forced to drive Britain’s economy into a recession to tame inflation.
At the end of a week of troubling economic developments, the chancellor, Jeremy Hunt, was being roundly criticised for appearing to say he thought this was a price worth paying, despite the pain already caused to families by an unrelenting cost of living crisis.
Keir Starmer, the Labour leader, said: “Almost nobody feels better off after 13 years of this government. I’m really worried about mortgages. People are struggling to pay the bills. Mortgages are a big part of that.”
Jagjit Chadha, the director of the National Institute of Economic and Social Research, said that if interest rates continue to rise, “we’re in danger of engineering a recession”.
As financial markets drove up UK government borrowing costs to the highest level since Liz Truss’s ill-fated premiership, the prime minister’s ability to deliver on his promise to halve inflation this year, one of five central pledges of his premiership, came into question.
Andrew Sentance, a former policymaker at the Bank of England, suggested Sunak’s promise was a “mistake” because it has been the central bank’s responsibility since it was handed independence by Gordon Brown in 1997.
“I would say if you believe the Clinton mantra that ‘It’s the economy, stupid’ – which I think is quite correct for the UK, and if the opposition looks competent – then it’s going to be quite a sticky wicket for the government economically next year,” he said. “The public can’t sack the governor of the Bank, so they express their dissatisfaction with the government.”
Official figures this week showed that the UK’s annual inflation rate fell by less than expected to 8.7% in April, with a steadying in energy prices largely offset by the soaring price of food.
Financial markets are now betting that the Bank will drive up its key base rate to as high as 5.5% from the current level of 4.5% before the end of the year.
Virgin Money became the latest big lender to increase its mortgage rates on Friday, with the cost of its fixed-rate deals edging higher. On Thursday, Britain’s biggest building society, Nationwide, hiked rates by up to 0.45 percentage points for those taking out a new mortgage.
After Wednesday’s disappointing inflation figures caused turbulence in the money markets, financial data firm Moneyfacts said 38 mortgage products had been withdrawn, and experts warned borrowers to brace for 5%-plus fixed-rate deals.
David Gauke, a former Conservative chief secretary to the Treasury, said the Conservatives’ best chance at the next election would come if living standards were improving and if interest rates were falling.
“The economy has performed better than expected so far in 2023, but if this means that inflation is going to be sticky and the Bank still has to go further to combat inflation, the economic pain is going to be badly timed for the government.”
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Former IMF deputy director Mohamed El-Erian said the Bank of England would be forced to raise interest rates higher for longer – which he said would mean recession or close to zero growth. “The risk we now have, you put all that together – sticky inflation, the Bank having to go higher, borrowing costs going up – all that translates into a higher threat of stagflation.
“I use stag for shorthand for insufficient economic growth. It can be recession, it can be zero growth. This is not about abstract numbers; it’s about something that hits the poor particularly hard.”
Treasury sources said they felt words had been put in the chancellor’s mouth that did not reflect his comments.
“If you look at exactly what he’s saying, it’s that inflation is the greatest reason for economic instability and why growth is slowing across the world, and it is the true threat that could cause a recession. Inflation is the No 1 enemy and we need monetary and fiscal policy aligned to tackle inflation and prevent a recession,” the Treasury source said.
The Liberal Democrat deputy leader, Daisy Cooper, said: “This would be a recession made in Downing Street. Rishi Sunak’s promise to grow the economy has been left in tatters. This government’s failure to cut inflation is sending mortgage rates spiralling as the Conservative economic chaos continues.
“Rishi Sunak and Jeremy Hunt could have acted to reduce energy bills and keep food prices under control. Instead, they’ve sat on their hands while inflation goes through the roof.”
Sunak had struck an optimistic note about the economy during his trip to the G7 in Japan last week, saying there were “lots of signs that things are moving in the right direction”.
He pointed to the positivity of chief executives about investment in the UK and argued that real household disposable income was “hugely outperforming what people thought”. The opposition criticised his comments as being out of touch with people struggling with their budgets during a cost of living crisis.
