Simon French: Times Business March 2022

High energy prices and the rising cost of food were already setting the UK economic agenda before war broke out in Ukraine. Since the Russian invasion the prices of these goods on wholesale markets have skyrocketed. Even experienced traders, battle-hardened by the Global Financial Crisis, the European Debt Crisis, Brexit, trade wars and COVID are squinting at their screens. It is not just today’s prices that have soared. The prices of basic staples for the UK economy like gas and wheat are elevated well into 2023.

Whilst futures markets sometimes attract a bad name, forward-buying will in fact provide some temporary relief for the economy. The passthrough from spot prices to shop prices is not immediate. However, it will be a temporary stay of price execution. It is increasingly likely that headline inflation – a broad measure of annual price increases – will hit 10% by the middle of the year. The weekly shop, filling up your car and the spill over into a much broader range of services will hit household incomes. UK growth is set to be just half what was expected at the start of 2022. If it wasn’t for the recovery underway from the COVID pandemic the UK would almost certainly be facing a recession.

Clear heads at the Bank of England and the Treasury will be needed to navigate this period. Limits on the effectiveness of interest rates – the traditional inflation-fighting tool – in bringing down inflation must be set against the risk that high inflation becomes embedded. Whilst recent talk of the politicisation of the Bank of England’s decisions tends to be overdone, by owning 40% of UK government debt its decisions from here have more profound political implications than any time since it gained operational independence almost 25 years ago.

Tax and spend policies will also need to respond to avoid acute financial hardship for the poorest households. Just one month on from Chancellor, Rishi Sunak, announcing a £9bn support package for households, this already looks underequipped for the challenges ahead. With energy-intensive businesses already reporting mothballing of activity the Exchequer – fatigued from its COVID interventions – will be asked to intervene again at the Spring Statement on 23 March.

Inflation on the scale now expected has not been seen in the UK for more than three decades. This comes with acute challenges for business plans and household budgets. The first-order impact is the prices paid for basic items. Here there are few changes to behaviour that can help. Thermostats can be turned down and the quality mix of food and consumer durables can be adjusted. However, such is the scale of the price changes underway that these alterations can only do so much. Shopping around imposes costs known in economics as “shoe-leather” costs to capture the time and effort this requires. Whilst online price comparison tools have reduced the relevance of this terminology – the principle remains.

However, it is the second-order effects that will determine whether this pricing shock has more long-lasting economic impacts. A volatile cost environment, at best, causes finance directors to hit the pause button whilst they assess the implications for long-dated contracts and investments. More problematic is if this pause becomes prolonged or stops investment altogether. The Bank of England expects business investment to grow by 14% this year – helped by a post-COVID rebound and the Treasury’s tax advantages for businesses that bring forward capital spending. The risks to this forecast have moved decisively to the downside.

Trying to predict what happens next, either with the war in Ukraine, or the implications for inflation and growth is riddled with risk. The best thing the government can do, beyond specific support for low-income groups, is reaffirm its commitment to its big agendas on Levelling Up, Net Zero and the Chancellor’s vision for sustained capital investment. Any signs that these will be ditched will just add to the uncertainty generated by events 1,500 miles to the East.

Author: Simon French, Chief Economist and Head of Research at Panmure Gordon, writing for The Times

Simon French

Managing Director, Head of Research