The Daily Telegraph - Saturday

Why Jeremy Hunt is happy to talk up a recession

Chancellor was reassuring markets, not voters, that he will tame inflation, reports

- Melissa Lawford

It was enough to send a chill through any voter. Speaking to Sky News, Jeremy Hunt was asked if he would be comfortabl­e with interest rates reaching such a height that the economy tips into recession.

“Yes,” he said. “Because in the end inflation is a source of instabilit­y. If we want to have prosperity, to grow the economy, to reduce the risk of recession, we have to support the Bank of England in the difficult decisions that they take.”

Such a bald statement is unlikely to play well with hard-pressed constituen­ts in either the Shires or the Red Wall – and, with the Conservati­ves still more than 15 points adrift in the polls, it has unsurprisi­ngly gone down badly with backbenche­rs too.

However, the comments make more sense if you realise that neither the voters nor the fractious Tory tribe are the intended target. Instead, Hunt is talking to an anxious City.

“There is a game here to just try and reassure the markets to make sure that we don’t get into a situation where they are disorderly,” says Andrew Goodwin, chief UK economist at Oxford Economics. “We know from experience the consequenc­es that brings after what happened last year.”

The downfall of Liz Truss still casts a shadow over Whitehall. Ministers and the Bank of England alike are fearful of the consequenc­es if markets believe they want to make short-term, popular choices with no regard for borrowing costs or surging prices.

If Hunt can convince traders that the Government will accept whatever it takes to bring inflation under control – even at the cost of an economic contractio­n – then it will pour oil on troubled waters, the thinking goes.

“Markets have become overly concerned by the inflation data this week. The extent to which market pricing is moving is significan­t,” says Goodwin. Representa­tives from the Bank are likely to give speeches taking a similarly hard line in the coming weeks, he adds.

The latest turmoil started on Wednesday, when data showed prices rose by 8.7pc in April, significan­tly more than the 8.4pc expected by the Bank. Worse still, core inflation – which strips out volatile components such as energy bills and food – is still rising, suggesting that pay growth is becoming embedded in the economy and driving prices up on its own.

This triggered a jump in borrowing costs and led to traders betting that the Bank will have to increase interest rates by a further full percentage point to 5.5pc in the coming months.

Such a steep increase in rates may be needed to prevent years of rising prices and falling living standards.

However, the risk is it acts as a brake on growth, as consumer spending, investment and hiring slow as a result.

Economists fear Britain has a 66pc chance of falling into recession. Under normal circumstan­ces, they would say there is a 30pc risk of recession, says Neil Shearing, group chief economist at Capital Economics. Now he thinks the risk is more than double that.

The economy will likely fall into a downturn in the second half of this year and the start of 2024, says Shearing. The housing constructi­on industry will be worst hit.

City traders have also started placing big bets on an economic downturn.

In normal circumstan­ces, two-year gilt yields are lower than 10-year yields. But this week this balance flipped in what is known as an inverted yield curve, because a downturn is regarded as likely in the short term.

“It means the market now expects there to be a recession at some point down the line,” says Thomas Pugh, UK economist at RSM accountant­s. The inversion gap is the largest recorded since February, when there were widespread forecasts of a recession from the likes of the Bank and the Internatio­nal Monetary Fund. The gap is roughly half the level recorded during the autumn mini-Budget crisis.

It is clear the outlook has rapidly become more bleak. “In February, people were expecting a recession, but the economy was much more resilient than we had thought,” says Pugh.

Now, the strength of the economy is a problem in itself. The resilience of the labour market and rising wages mean inflationa­ry pressures may have become endemic. Wage growth is at around 6pc, double the 3pc rate the Bank of England says is consistent with 2pc inflation. Althea Spinozzi, senior fixed income strategist at Saxo Bank, says it may be impossible to raise interest rates enough to tame inflation without severely harming the economy. A Bank rate at 5.5pc could trigger a fresh wave of financial turmoil, akin to that seen in the US in March, she says. “The financial system has showed weakness far before we have got to 5pc,” she says. “If rates continue to rise, then we are likely to see something else breaking. There are issues not only with the pension funds but also what we have seen in the US.”

The financial system has adjusted to low interest rates since the financial crisis. “Institutio­ns have taken risks based on very low rates,” she adds.

But Andrew Bailey, the Bank of England Governor, is hamstrung. “The Bank must choose between inflation or a very deep recession,” says Spinozzi. “If it doesn’t get a hold on inflation, there will be a recession anyway.”

For now, there is a false dawn. Data such as the purchasing managers’ indices suggest economic performanc­e will be OK over the next few months, says Shearing. The real toll is coming in six months’ time. But for the Chancellor, it may be a price worth paying to avoid the same fate as Truss.

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