UK buyers remain calm and carry on. Why? | Larry Elliot

JThe British economy is a puzzle. Inflation has topped 10% for the first time since Argentina prepared to invade the Falklands in early 1982. Prices are rising much faster than wages. Consumer confidence has reached depths not seen during the many woes of the past half-century.

And yet, official data shows that the British public is still shopping despite everything. Retail sales were higher in July than they were in June despite mounting pressure on living standards. Airports are crowded with vacationers, house prices keep rising. Curious sort of crisis, one might think.

One possibility is that the gloom surrounding the economy has been exaggerated. Unemployment is low and vacancies are plentiful. People are not afraid of losing their job and if they are made redundant, they can hope to find another one fairly quickly.

Demand for vacations abroad is strong as many households built up savings during the pandemic when spending opportunities were limited. These cash reserves are now reduced, closing the gap in the cost of living left by rising inflation.

Yes, the Bank of England has raised interest rates at the last six meetings of its monetary policy committee, but in real terms – adjusted for inflation – borrowing costs are still low. Put all these factors together and it’s safe to say that the UK will experience a relatively mild downturn this winter.

Even the dire state of consumer confidence can be explained, as a breakdown of the latest sentiment snapshot shows people are much gloomier about the state of the economy than they are about their personal finances. . Negative wall-to-wall reports of a looming cost-of-living crisis have been registered but, so far at least, households believe they are getting by.

It is curious, to say the least, that the confidence measured by GfK is lower than it was during the three-day week of early 1974, the deep manufacturing recession of the early 1980s and the period in 2008 when it also looked as if the banking system was collapsing. This may reflect the pervasive nature of modern media, and especially social media, rather than objective economic conditions.

This is the optimistic point of view. There is an alternative, with consumers in denial about the horrors to come and having one last spending spree before tightening their belts during the perfect fall storm.

The gloomy view of the economy goes something like this. Growth all but came to a standstill in the first six months of 2022, with production increasing slightly in the first quarter and decreasing slightly in the second quarter. The labor market is at a turning point: job growth is stagnating and the number of vacancies is falling.

For now, this is a relatively slow process and many companies are able to pay more than they would like to attract and retain staff. For now, they believe they can pass the cost of higher wages on to their customers by raising prices. The resumption of retail sales growth will hardly discourage them from doing so. This will feed into core inflation – the cost of living excluding food, fuel, alcohol and tobacco – which is closely watched by the Bank of England and which topped 6% last month.

Double-digit inflation and signs that consumer demand is holding up make it more likely the Bank will raise rates by 0.5 percentage points next month, following a similar increase in August.

This will add financial pressure on consumers and businesses, just as rising domestic fuel prices are biting. The increase in the energy price cap in October will further increase the annual inflation rate, putting further pressure on real incomes and massively increasing fixed costs for millions of businesses.

Much attention has been paid to what Boris Johnson’s successor will do to ease the pain about to be inflicted on households, but less attention to what they should be doing to help businesses. In the short term, restaurants, hotels and high street shops will try to pass on their higher costs, but they will be less successful as consumer demand weakens in the fall than it did in the summer. Many will throw in the towel.

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Industrial unrest will bring another dimension. Figures from the Office for National Statistics last week showed total annual wage growth in the private sector of 5.9% and 1.8% for the public sector.

With inflation of 10.1%, this represents a drop in the standard of living of more than 4% in the private sector and more than 8% in the much more unionized public sector. Inevitably there will be more strikes as workers – who can rightly say they are not to blame for the cost of living crisis – seek to avoid further impoverishment.

The Bank of England is leaning towards the darker of these two scenarios, which is why it predicts a prolonged recession for the UK in which unemployment will rise by more than a million. Threadneedle Street thinks good news (such as strong retail sales) is unlikely to persist, and that seems like a reasonable call.

While that won’t stop the Bank from continuing to raise short-term interest rates, by this time next year the monetary policy committee will be under pressure to cut them. The economy may look strong. The job market can seem to defy gravity. But it’s really just a mirage. Consumers are right to be depressed even if they don’t quite appreciate what’s to come yet.

About Valerie Wilson

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