High prices and low growth should nip UK and eurozone interest rate rises in the bud

Central banks talk tough about tackling inflation, but raising borrowing costs now risks plunging us into recession this year

A recession lurks just around the corner. That’s what many economists and financial analysts in the UK and across Europe fear as inflationary pressures collide with the Russian invasion of Ukraine to undermine the post-Covid recovery.

On Monday, the Office for National Statistics will report on how much the UK economy expanded in February. Any chance of matching January’s GDP growth looks optimistic.

Sanjay Raja, senior economist at Deutsche Bank, believes that after January’s rise of 8% – well above most analysts’ expectations – growth will fall to just 0.1% in February, dragged down by a dip in industrial production. “The bad news is that we don’t expect the recent strength in activity to last very long,” he said, adding that a decline in March was also likely, which will mean GDP growth in the first quarter may not even reach 1%.

A contraction in the second quarter is almost certain, given “a bigger jump in energy and food bills, higher taxes, a reversal in Covid health spending, some unwinding of stocks in the manufacturing sector, and the extra June bank holiday”.

Suren Thiru, head of economics at British Chambers of Commerce, said the combined growth rate in January and February would seem like a high-water mark: “When we look at February’s figures, it will feel like we are looking in the rear-view mirror.”

Thiru agrees with Raja that it will be downhill from March for the UK. GDP in the second quarter, from April to June, is likely to contract. Economic convention says that if there is a second quarter of negative growth from July to September, the UK will officially be in a recession.

At the moment, few forecasters are suggesting that the UK is about to experience two consecutive quarters of negative growth, but most say the risk to their predictions is undue optimism. Uncertainty, in particular, is a growth killer and there is plenty of economic uncertainty around at the moment.

A long war in Ukraine, increased sanctions against Russia and oil prices that stay above $100 a barrel will probably push inflation to even higher levels and undermine any sense among businesses and consumers that it is safe to make investment decisions.

A gas price that continued to be more than five times its pre-pandemic level, fuelling a cost-of-living crisis, would only make matters worse, said Thiru.

Consumer confidence has slumped in recent months, and now stands at the low levels registered before the second lockdown in 2020. Business confidence has also crumbled, according to the Lloyds Bank business barometer. Lloyds said March’s fall in confidence was the biggest since the first two months of the pandemic.

The situation could worsen if central banks misread the signals from the economy and persisted with plans to raise interest rates, said Dario Perkins, an economist at consultancy TS Lombard. He argues that the Bank of England – and possibly the European Central Bank – are poised to make a historic mistake that could plunge their respective economies into recession.

Both the Bank and ECB have talked tough about tackling inflation with higher borrowing costs. Financial markets predict that the Bank of England could push its base rate to 2% next year, from the current 0.75%.

“Rapid monetary tightening outside the US is likely to end in a Trichet-style fiasco,” said Perkins.

He is referring to the aftermath of the 2008 financial crash when, seeing commodity prices, and especially the price of oil, rocketing, ECB boss Jean-Claude Trichet was convinced that he needed to begin increasing interest rates.

The highly indebted eurozone economy was unable to cope and by 2012, the continent was plunged into a crisis that almost brought the euro project to an end.

Albert Edwards, the global strategist at Société Générale, said just the threat of higher interest rates in the US had already made borrowing more expensive and had capped the number of interest rate rises that were needed. That should prevent the Federal Reserve pushing its base rate above 1%.

The UK may see rates rising to slightly above this level, while the eurozone, where interest rates are currently negative, could be looking at its first positive interest rate since 2012. But concerns about increased rates leading to a recession are almost certain to stay the hand of most rate-setters.


Phillip Inman

The GuardianTramp

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