As the UK faces a cost of living crisis, stubborn inflation rates, and potential risks of what I believe to be a 'cost of credit crisis,' households and businesses find themselves grappling with the harsh realities of a future burdened by economic instability. The UK government and the Bank of England (BoE) have been striving to address these challenges, but the consequences of their decisions are yet to unfold fully.
The UK economy has been battered by the war in Ukraine, Brexit, and the COVID-19 pandemic. These combined shocks have had a significant impact on living standards, productivity, and growth. The Office for Budget Responsibility (OBR) has warned that living standards may not return to pre-pandemic levels for another five to six years. Inflation is predicted to fall below 3% this year, down from 10.1% currently. However, this outlook remains volatile as the UK is a net importer of food and energy, the prices of which are determined by global markets.
As inflation remains persistently high, driven by soaring food prices, striking public sector unions are demanding increased pay awards for 2023-24, a prospect that Chancellor Rishi Sunak aims to resist. Core inflation, excluding food and energy prices, remains unchanged at 6.2%. The Bank of England has raised interest rates 11 times since December 2021, trying to combat inflation. The latest rate rise pushed the interest rates to 4.25% from 4%, in response to the inflation rate unexpectedly rising to 10.1%.
The financial consequences of these economic events have hit households and businesses particularly hard. A study by the Resolution Foundation reveals that nearly two-fifths of people aged 35 to 44 have borrowed money to make ends meet, while almost a quarter of those under 35 have turned to their parents for help. Low-income families are falling behind on bills, with approximately 500,000 people, equivalent to 6% of low-income households, using food or warm banks in the past four weeks.
For businesses, high inflation and the ensuing wage-price spiral have added to the burden of rising costs. As companies attempt to protect their profit margins by raising prices, workers seek higher wages, driving up costs further and perpetuating the inflationary cycle. To counter this, the BoE has raised interest rates, with the potential for additional hikes in the future. While interest rate hikes are intended to moderate inflation, the lag in the monetary policy 'transmission mechanism' means that the hikes will only begin to affect the real economy in the coming quarters.
This delay in policy impact could result in an accompanying 'cost of credit crisis,' as real interest rates carry over into the real economy. The post-pandemic trend of a strong rebound in consumer credit, driven by low-interest rates and high household saving ratios, has created an environment ripe for a surge in economic activity and credit demand.
Despite a declining inflation rate, households will likely continue to face a financial strain, with many forced to allocate larger shares of their earnings towards debt repayments. Businesses will have to navigate the challenges of higher interest rates, wage demands, and fluctuating costs, potentially leading to closures or downsizing. The unfortunate reality is that UK households and businesses face an uncertain and challenging future.