The U.K. Economy Is in Turmoil, But There Are Signs of Hope

TThe death of Queen Elizabeth II and the ensuing period of national mourning was the latest blow to an already ailing British economy, but economists and analysts say there are glimmers of hope.

Britain is at a turning point. The country has just concluded a 10-day period of mourning, ending with nationwide closures during a public holiday to mark the late monarch’s funeral. Her death came just two days after a new prime minister, Liz Truss, took office after the last was ousted by his own party for disorderly conduct as Britain grapples with a cost of living crisis the nation has never seen decades. Inflation has risen to around 10%, its highest level since the 1980s, and the country is facing an energy crisis due to dwindling Russian energy exports to Europe. The British pound is at a near 37-year low against the dollar. And economic growth – Britain has now fallen behind India, a former British colony, to become the world’s sixth-biggest economy, and its central bank, the Bank of England, has warned it risks sliding into a recession that could last until could last well into 2024.

Queen Elizabeth II’s death is the latest to touch the British psyche. Although the monarchy is often viewed as an anachronism, it is still an important part of British life. It is likely that this will continue under the new monarch, King Charles III, who joined after the Queen’s death.

“It really does feel like we’ve entered a new era for the UK as a whole,” says Craig Erlam, senior market analyst at multi-asset broker OANDA. “This is a very interesting time for the country and its place in the world.”

In many ways, the monarch plays a symbolic role, not a political one. That means the change shouldn’t be too controversial, Erlam says. However, it is a difficult plot to follow. “She was an incredibly popular character,” he says. “I just wonder if there’s the same love and devotion for King Charles.”

Britain’s mounting economic pressures

When economic growth for the third quarter is released, it could show that the holiday for Queen Elizabeth II’s funeral on September 19 has weighed slightly on economic growth, pushing the economy into a technical recession with two consecutive quarters of negative growth. says Steve Clayton, head of equity funds at UK-based Hargreaves Lansdown. This is due to lower productivity and economic output. A similar thing happened in the second quarter, when an extra bank holiday was granted to celebrate the Queen’s platinum jubilee and the economy contracted 0.1%, according to data provider Trading Economics. “Whatever impact there will be, it will only be temporary,” he says. That’s because it probably won’t change spending on cars, TVs, groceries, and other things, he says. Additionally, some food banks were scheduled to close on the day of the funeral, meaning those in need might not be able to get essentials.

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That’s not to say spending habits haven’t changed. Clayton has noted a fall in consumer spending, likely sparked by the country’s energy crisis and recent interest rate hikes. British grocery delivery service Ocado, popular with middle-class consumers in Britain, recently reported that its customers are spending less, sending the company’s shares plummeting. Clayton says that’s also partly the harsh reality of higher home loan costs.

Many homebuyers use adjustable rate mortgages to buy real estate. The Bank of England raised interest rates to 1.5% from 0.35% last November. This will directly impact the many UK residents with adjustable mortgages. Worse, the central bank hiked interest rates by 0.5% today – the seventh straight hike – cutting many Britons’ budgets in the process. “This is going to be painful for those with large adjustable-rate mortgages,” says Clayton.

Then there’s the energy crisis, which threatens to plunge half of households into fuel poverty. The cost of natural gas in Europe has more than tripled recently, from around €70 a year ago to €217 ($217) per kilowatt-hour, according to Trading Economics data. The rise came as Russia halted natural gas supplies to Europe after invading Ukraine. This jump in price is directly reflected in higher electricity prices and heating costs.

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Earlier this summer, Britons were warned that energy bills could top £6,000 ($6,960) a year by April 2023 due to higher heating bills this winter. That’s almost 20% of the average annual after-tax household income of £31,500, according to government statistics. Some people won’t have the money to pay their bills, experts say.

Financial research firm Red Flag Alert has also warned that more than one in five UK businesses with sales above £1million ($1.16million), about 76,000, could go bankrupt because of higher energy bills. People with high energy consumption, such as industrial companies, are more at risk.

Liz Truss’ emergency response plans

Two days after his appointment as Prime Minister, Truss announced a cap on household energy bills at an annual rate of around £2,500 for the next two years, with the Government paying the difference. The government has also unveiled a £40 billion ($45 billion) plan to help businesses and cap wholesale energy prices for businesses for six months. Some criticize such measures as filling the coffers of energy companies looking to make record profits from rising energy costs.

The UK’s new Chancellor of the Exchequer, Kwasi Kwarteng, is set to announce the government’s much-needed plan to deal with the cost of living crisis on September 23. The so-called “mini-budget” should include tax breaks for companies and private individuals as well as the elimination of unnecessary regulations.

“One of the most compelling stories is the UK’s policy mix,” said Marc Chandler, Managing Director at Bannockburn Global Forex. In concrete terms, this means loose fiscal policy (more spending, lower taxes) and tight monetary policy with higher interest rates. Such was US policy in the early 1980s, leading to a period of rapid growth.

Chandler also believes the policy mix will help in part with the country’s other problem: the falling value of the pound, which recently hit its lowest level since the mid-1980s. He says the pound’s fall was largely due to the dollar’s outrageous strength. Other rich country currencies have fallen by similar amounts, notably Europe’s common currency, the euro, and the Japanese yen. Sterling has rarely been as undervalued as it is now, says Chandler, and he expects it could rally once the dollar tops out, which he predicts will happen in early 2023.

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Truss also wants to ensure a future with stable energy supplies, says Ivo Pezzuto, professor of global economics and digital transformation at the International School of Management in Paris. Higher prices lead to lower demand, but that doesn’t fix the fact that the Kremlin stopping natural gas supplies is a supply problem in Europe. “They need more supplies,” he says. Gone are the days when an economy was built around cheap Russian oil and gas.

Unlike the rest of Europe, the Truss Plan does not include a tax on windfall profits from energy companies. She wants to encourage more drilling and has lifted the ban on hydraulic fracturing oil drilling – or fracking. There are also discussions about introducing a robust energy policy that embraces new technologies, including nuclear power and renewable energy. “Some of these will take some time before the benefits kick in,” says Pezzuto.

There are other signs of hope for the economy. The unemployment rate is 3.6%, the lowest since the 1970s. There are now 1.3 million job vacancies versus 1.5 million unemployed. Simply put, the job market is tight, giving workers the opportunity to demand higher wages, which in turn helps offset the rising cost of living. “Employers aren’t likely to keep wages low for long,” says Clayton.

But there is a caveat to rising salaries. If wage demands balloon too much, the Bank of England could worry about persistent inflation. The result could be aggressively higher interest rates, says Konstantinos Venetis, director for global macro at London finance firm TS Lombard. If that happens, the economy could take a hit.

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