Inflation pushes Britain to the brink of recession

Steep price rises coupled with higher taxes are taking an economic toll,

Brief hopes of a “roaring Twenties” rebound from Covid have fizzled out, leaving the UK on the brink of recession. Britain’s current GDP has barely risen to above its pre-coronavirus level and the economy is already shrinking.

While March’s 0.1pc dip in GDP is far from the only wobble on the road to recovery – in December, for instance, the economy shrank by 0.2pc – it is being viewed as the herald of a new downturn. The dip at the end of last year was caused by omicron, another outbreak of Covid scaring Christmas shoppers away from the high street and keeping would-be festive revellers at home instead of heading to bars.

But this time the dip is different. Now, GDP is down because inflation is on the rampage, with prices shooting up in a way Britain has not seen for a generation. An oil shock on a par with the 1970s, combined with supply chain carnage, has sent inflation up to its highest since 1992 – and potentially soon to rise to levels not seen since the early 1980s.

While help was on hand in the pandemic, with furlough, business rates breaks and Eat Out to Help Out dished out by the Chancellor, this time around Britain has been ordered to take its medicine. Higher taxes are the order of the day, with Rishi Sunak’s pockets swollen by the National Insurance increase even as households see their pay packets gobbled up by the health and social care levy and rising prices.

The Office for Budget Responsibility (OBR) predicted in March that real disposable household incomes would fall by 2.2pc this year, among the steepest drops ever recorded.

The Bank of England’s predictions this month, with the strength of the inflation explosion becoming ever clearer, puts the loss at 3.25pc.

At the same time, the Bank is raising interest rates in a bid to combat inflation – again in contrast to the Covid policy of slashing borrowing costs – but one that comes at the cost of undermining economic growth.

Inflation hit 7pc in March. The Bank of England estimates it is now already at 9pc and could jump into double figures later this year. This is eating into families’ spending power as wages rose by just 5.4pc in the 12 months to February: nowhere close to keeping up with the cost of living.

Officials, led by Andrew Bailey, the Bank of England Governor, have acknowledged the risk of recession, predicting a drop in GDP towards the end of this year when the energy price cap rises again, with the result that the economy will be smaller next year than it is this year. March’s figure of 0.8pc growth in the first quarter was below that anticipated by the Bank, meaning the outlook is already worse than the Monetary Policy Committee thought at the start of the month.

Yet more rate rises are still needed, says Paul Dales at Capital Economics.

“With the full hit of the cost-of-living crisis yet to be felt, the chances of a recession have just risen,” he says.

“Even so, with price pressures still strengthening, the Bank of England may have no choice but to add to the woes of households by raising interest rates further.”

The best hope of dodging a recession is that GDP will bounce in a haphazard pattern this year, which evades the usual formal definition of two consecutive quarters of contraction despite being every bit as painful.

For instance, GDP in the current quarter will take a knock from the jubilee bank holiday, which gives much of the workforce a day off. This break will not be repeated in the third quarter, and that extra day of work could be enough to push GDP up in the three months to September, missing the formal definition of a recession, even as energy bills jump again just in time for the winter, sending output down again in the fourth quarter.

Expect a messy, painful year that feels like a recession, regardless of whether the bean-counters officially name it such.