The economy of the United Kingdom entered the deepest recession since the Second World War during the Global Financial Crisis. As a result, the UK economy was 16% smaller in 2018 than it would have been had it followed the pre-crisis trend. What’s more, Covid-19 created the largest public health crisis in more than a century, Brexit has walled the United Kingdom off from trade with the European Union, and geopolitical tensions are growing in both frequency and magnitude. Ultimately, with inflation hitting 41 year highs of 11.1% (October 2022) and a looming recession, the economy is undergoing a stagflation crisis.
Section One - Inflation
Inflation may be defined as a general increase in the prices of goods and services within an economy, or alternatively as a decrease in the purchasing power of money.
The United Kingdom’s rampant inflation, 6.7% as of September 2023, has wounded the growth of stocks and bonds, raised interest rates, exacerbated uncertainty, reduced the international competitiveness of exports, and significantly lowered the purchasing power of consumers.
First, whilst Brexit isn’t responsible for any sudden, or drastic, rise in the general cost of goods and services, it laid a strong foundation for cost-push inflationary pressures to be further developed. Before Brexit, trade with EU countries was chargeless and subject to less red-tape, however substantially more paperwork and checks are required with the return of custom borders. In May 2016, before the referendum, one pound was worth €1.32, falling to a relative low of €1.11 just five months after. Currency depreciations lead to imported factor inputs becoming dearer as more domestic currency is required to purchase foreign currency in order to obtain the desired factor inputs. Ultimately, Brexit has greatly contributed to cost-push inflationary pressures through increasing border controls and non-tariff barriers, weakening the value of the pound and heightening transportation costs.
The first wave of inflation was pioneered by Covid-19 and resultant lockdowns. As international trade plunged during 2020, cost-push inflationary pressures arose due to supply-side bottlenecks. Demand-pull inflationary pressures arose too, laying at the door of pent-up demand for consumer goods and services, supported by unparalleled monetary and fiscal measures. Between March 2020 and July 2021 - the United Kingdom’s bout of lockdowns - aggregate savings rose as spending on services was prohibited, and households contemplated the possibility of unemployment and further lockdowns. Therefore, as restrictions began to subside, households had an excess of real disposable income and there was an upsurge in consumption. Businesses, owing a reduction in their profit margins to bottlenecks, took advantage of heightened demand and hiked their prices to restore profitability, consequently creating the first inflationary pressures. Inflation rose from 0.8% in December 2020 to 4.8% in December 2021.
When interest rates are low the return on savings fall, and households seek to place their money into other financial instruments. Also, with the amount charged on loans falling consumers increase consumption and businesses expand operations, ultimately bolstering the economy. Therefore, with the Bank of England slashing interest rates to 0.1% between March 2020 and December 2021, consumers' already pent-up demand for consumer goods and services were further strengthened. What’s more, the Bank of England printed £500 billion to purchase government bonds and other financial assets to stimulate the economy (quantitative easing). In short, supply-chain bottlenecks raised the cost of production for businesses, but ample demand from households allowed businesses to raise their prices.
The inflation rate of the United Kingdom really began to pick up steam in February 2022 - the beginning of the Russia-Ukraine war. Fortunately the UK does not have significant direct trade links with either Russia or Ukraine, so we haven’t been greatly affected by rising import costs or seen a noticeable decline in export volumes. Nonetheless, the UK is greatly exposed to fluctuations in the global price of energy - about 3% of the UK’s gas comes from Russia and about 4.5% from the EU (Russia provides European countries with approximately 40% of their gas). As a result, the UK saw gas and electricity prices rise by 96% and 54% respectively between July 2021 and July 2022. This directly increases the domestic ‘pump’ price of petrol and diesel, pushes up domestic retail energy prices and raises the cost of producing other goods and services. Global supply-chain disruptions are a complicated matter as it is challenging to differentiate the consequences of Covid-19, Brexit and the Russia-Ukraine war. Nevertheless, the conflict has still contributed to vast supply shortages, particularly food shortages - food and drink prices have jumped about 25% in the past two years alone, the same level of price growth seen over the preceding 13 years. The compounding effects of demand-pull and cost-push inflationary pressures - attributed to Brexit, Covid-19 and the Russia-Ukraine war - ultimately led inflation in the United Kingdom economy to reach a staggering 11.1% in October 2020.
It is believed that inflation will continue to slow and trend downwards, returning to normal levels by the end of 2025. This is attributed to the effects of higher interest rates generally decreasing consumption in the economy, falling gas prices and global-supply chains beginning to ease. However, there is no guarantee that disinflation will continue as we cannot guarantee there won’t be any future negative supply-side shocks, and even as inflation cools prices are still increasing and will remain higher than they have been previously.
Section Two - Economic Growth
Economic growth, measured by an increase in gross domestic product, measures the total number of goods and services produced within an economy in comparison to previous periods. Economic growth is often viewed as the important macroeconomic indicator as it drives growth in employment, increases taxation revenue, leads to improvements in people's quality of life, and incentivises investment and innovation. However, the goal of macroeconomic policy is to provide a stable economic environment that is conducive to fostering strong and stable economic growth. As a result, we cannot properly progress as a country without low and stable inflation.
Real gross domestic product dropped 11.0% in 2020 as economic activity was brought to a halt. Following 2020, however, real gross domestic product boasted gains of 7.6% and 4.1% in 2021 and 2020, respectively. In 2021 and 2022 the economy was undeniably beginning to grow again as production increased, labour force participation rose and consumer and business confidence recovered, but the aforementioned metric compares growth to the previous year so the growth rates appear stronger than they truly are.
2023 has seen lacklustre growth; Q1 2023 experienced 0.3% economic growth, Q2 saw growth at 0.2%, and in the third quarter growth flatlined. What’s more, it is predicted that the United Kingdom will continue to see growth flatline in 2024, with the possibility of a mild recession in the first two quarters.
In 2023, the implications of Brexit, Covid-19, the Russia-Ukraine war and monetary tightening have mounted, creating a low growth environment with general price levels still rising significantly higher than desired. UK households have seen their expenditure greatly rise as they battle the cost of living crisis, and struggle to keep up with, for example, rising variable-mortgage repayments as interest rates soar. 2024 is set to be a year characterised by slow or negative growth, slight rises in unemployment, and continued restrictions on government spending as the budget deficit further worsens. Yet, with lower levels of aggregate demand in the economy, the inflation rate will likely fall - returning price stability. Economists believe that by the beginning of 2025 the economy will return to normality - an economy characterised by lower interest rates, employment beginning to fall, and low and stable economic growth and inflation.
By Charlie Pilling
Blogger
Edited By Samuel Golder
CEO
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