Scottish Daily Mail
As interest rates peak, the worst is behind us. Here are my reasons to be cheery
THE Bank of england raised its key interest rate again on Thursday, taking it up another 0.25 per cent to 4.25 per cent, the highest level in almost 15 years.
Given the banking turmoil sparked by the run on California’s Silicon Valley Bank (SVB), some expected the Bank to pause its rate rises. But the Old Lady of Threadneedle Street decided it still had to wage war against inflation, which unexpectedly jumped to 10.4 per cent last month, so up rates went for the 11th consecutive time.
Even so — and despite the perpetual gloom in which Britain’s chattering classes continue to wallow — there are reasons to be cheery as spring begins and summer beckons, even for Prime Minister Rishi Sunak.
For a start, we’re getting close to the peak in interest rates, which is good news for households with a mortgage and small businesses with loans. I don’t say interest rates won’t increase again — the Bank might still have another quarter-point rise in it yet — but I very much doubt it will go beyond 4.5 per cent, which is a lot less than the 6 per cent feared only last autumn.
The markets are even pricing in a 0.5 per cent cut in interest rates by year-end, which might be a tad optimistic, but they will certainly be falling by early 2024. The Government is already paying lower interest rates on its national debt mountain: ten-year Government bonds (called gilts in the UK) now pay under 3.2 per cent while two-year bonds pay barely 3 per cent. Interest-rate relief for the rest of us is on the horizon.
Significantly, the Bank has joined the Office for Budget Responsibility (OBR) and other establishment gloomsters in revising upwards its downbeat economic forecast for 2023.
Only a few months ago it was predicting the UK economy would be in recession this year and that downturn would linger into 2024. Now, like the OBR, it doesn’t think there will be a recession.
True, it now reckons (also like the OBR) that the economy will merely flatline for most of this year, which is not great but is better than a prolonged downturn.
Retail sales rose 1.2 per cent last month and were revised upwards to 0.9 per cent for January, suggesting that despite the cost-of-living crisis people are still spending. J.D. Wetherspoon, the pubs chain and something of a weathervane when it comes to consumer spending, is back in profit and says it has now overcome its supply chain problems and labour shortages.
Early signs indicate the economy might have grown by 0.2 per cent in the first quarter of this year, which would hardly set the heather on fire but would be further evidence that a recession is not imminent. We might even do a little better than merely tread water for the year.
The inflation dragon, of course, remains to be slain. February’s unexpected uptick casts some doubt on official and unofficial forecasts that it will be below 3 per cent by year-end.
Rising prices are proving more stubborn here than elsewhere: Britain has the highest inflation rate in the G7 group of big market economies. Indeed we’re the only one still to suffer from doubledigit price rises.
But the savage rise in food costs which propelled February’s jump will soon start to abate. The collapse in wholesale energy prices will soon be reflected in household fuel bills, which will fall to around £2,000 on average this summer, meaning the Government will no longer have to subsidise them at great expense.
So there’s a chance that inflation could start to tumble fast by late spring or early summer and continue to fall for the rest of the year. even if it doesn’t quite slip below 3 per cent by Christmas, a steady decline would reinforce the case for interest rates to start to fall, too.
Moreover, most folk haven’t clocked that many forecasters think inflation will fall to around 0 per cent sometime in 2024. If that happens the Bank will be cutting interest rates aggressively next year and the new fear would be deflation (steadily falling prices), requiring a very different economic policy response than inflation.
Even without deflation, low inflation would mean the end of the cost-of-living crisis, which has caused so much misery in the wake of Russia’s unprovoked invasion of Ukraine a year ago.
That would further boost consumer spending and so economic growth.
The omens are encouraging. The current pay round is coming to an end. The Government has managed to avoid too many high wage settlements which would have baked inflation into the system.
Unions have secured decent pay rises but the vast majority do not match inflation, and none has come close to what unions originally demanded. Belowinflation pay rises, of course, add to the pain of the current cost-ofliving squeeze, but they also avoid worse to come in the future.
If inflation had become embedded in the economy only a destructive recession would have squeezed it out. We have managed to avoid that. The next pay round will start with substantially reduced inflationary expectations. As I say, reasons to be cheery.
Of course, there are plenty of pitfalls ahead, the most obvious being a crisis in the financial system caused by the current jitters in the banking sector.
Three mid-sized American banks have already collapsed, led by SVB; a fourth (First Republic) is teetering on the brink and having to be bailed out by other U.S. banks; and the Swiss government has forced the country’s biggest bank, UBS, into a shotgun wedding with its long-ailing rival, Credit Suisse (the banking equivalent of Celtic taking over Rangers — which gives you an idea of the scale of the crisis in Swiss banking!).
The consensus is that bank regulators and central banks on both sides of the Atlantic have done a good job stopping the problems of individual banks, almost all caused by the sudden and steady rise in interest rates driving down the price of bonds, from sparking a wider contagion in the financial system.
But the nervous nellies were out in force again yesterday when sentiment turned against Deutsche Bank, a German giant which has had plenty of problems of its own in recent years.
Its share price plunged, dragging other bank stocks down with it, including the shares of Britain’s major banks.
Again, the problem looks like it’s being contained, but we’ll be walking on thin ice for some time to come before we can be sure there will not be a financial meltdown.
Assuming there isn’t one, the prospects of a better 2023 for Britain than seemed likely only a few months ago has important political implications.
There’s been a spring in Sunak’s step in recent weeks as he develops a reputation as something of a problem-solver.
He’s secured a new deal with the european Union over Northern Ireland (reducing hardline Tory Brexiteers to a rump in the process). he’s cut Britain into a major share of the action in the historic Aukus submarine deal
Pubs chain Wetherspoon is back in profit
Cost-of-living crisis could be over next year
Tories may end 2023 in much better shape
with America and Australia. And he’s managing to return Albanian migrants arriving illegally on our shores to Tirana for processing — even if the wider problem of the boat people remains to be cracked.
And this week he benefited from his biggest rival, Boris Johnson, looking like yesterday’s man with yesterday’s problems when he appeared before the Commons Privileges Committee.
A few weeks ago I asked a leading member of the shadow cabinet how robust he thought Labour’s lead in the polls over the Tories was. ‘It’s not robust at all,’ he replied. ‘In fact, it’s very soft.’ Since then Labour’s lead has fallen from almost 30 per cent on average to under 20 per cent.
The odds are still on Labour winning an overall majority big enough to last five years. There is a lot of visceral hostility to the Government out there, for understandable reasons.
But the Tories can console themselves with the thought that Armageddon doesn’t look as likely as it did only a few months ago.
If this year inflation dissipates, the cost-of-living crisis disappears and, instead of recession, there is modest growth, as a precursor to robust growth next year, then the Tories will end 2023 in better shape than they started it.
Labour will grow uneasy and become prone to mistakes.
The Tories will still have a mountain to climb to secure a fifth term but Sunak will have given them an outside chance — and an outside chance is better than no chance at all.