With the UK economy experiencing one of its worst periods in recent times, Investment Monitor examines just how bad things have got.
The UK has the highest inflation rate among the G7 countries. In August 2022, the UK’s consumer price index (CPI) stood at 9.9%, which means prices in the UK were almost 10% higher in August 2022 than they were in August 2021. Households in the UK are feeling the squeeze in their purse strings.
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Rising energy prices are impacting transport costs, a key driver of the overall increase in inflation. Although motor fuel prices fell from July, contributing to the slight decline in overall CPI figures in August, pressures still exist. Equally concerning was the rise in prices of food and non-alcoholic beverages, which were 13.1% higher in August 2022 than they were in August 2021.
France has managed to keep a grip on its inflation mainly due to its use of nuclear power to offset the rise in global gas prices caused by Russia’s invasion of Ukraine. The US is seeing inflation begin to fall after the Federal Reserve increased interest rates to encourage savings and curb spending. The strong dollar has also afforded the US stronger purchasing power in global commodity markets.
The falling pound begins to recover
The British pound has begun to recover after its alarming crash in the aftermath of Chancellor of the Exchequer Kwasi Kwarteng's much-criticised mini-budget in late September 2022. This recovery came after the UK government decided to scrap its proposed removal of the 45% rate of income tax for the country's highest earners and the Bank of England announced the temporary purchase of £65bn-worth of gilts.
However, its fall is still impacting the UK’s economy, making imports more costly and contributing to rising domestic prices. The weakening of the British pound dilutes the UK’s purchasing power for foreign goods and services.
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By GlobalDataThe falling pound makes economic growth more difficult as investors find UK assets less attractive. The Bank of England is monitoring the situation closely. It is expected that there could be an increase in the UK’s interest rate in November 2022 to control rising inflation and strengthen the value of the pound. However, this could see millions of UK households facing significantly higher mortgage repayments – a substantial portion of most people’s expenditures. The government faces the difficult task of reducing inflation while limiting the impact on household finances.
Political naivety causing serious consequences
Liz Truss became the UK's prime minister in September 2022, and her government released a mini-budget that created turmoil within the British economy. The public backlash has been unwavering, so much so that Kwarteng revoked the abolishment of the 45% top rate of income tax shortly after it had been announced, after significant pressure was exerted by senior Conservative politicians after the party slumped in opinion polls. The measure was criticised by many as representing 'trickle-down economics' which would see the rich get richer at a time when large chunks of the UK population were entering economic poverty.
The UK government is certainly taking bold steps to try to drag the UK economy out of a looming recession. However, its rationale of tax cuts and increased borrowing to speed up growth will lead to increased government debt and potentially problems in the medium to longer term. Even in the short term, investors react quickly to government changes. The government’s decision to decline an independent assessment of the impact of its plans by the Office for Budget Responsibility only added to the market turmoil.
Low growth and worrying outlook for the UK economy
The UK economy is struggling. Although the prospects of it entering a recession – defined as two consecutive quarters of negative GDP growth – are certainly not guaranteed, it is possible. The likelihood is that the UK’s GDP growth will be in negative territory in the final quarter of 2022. According to the UK’s Office for National Statistics, monthly real GDP growth is estimated to have risen by 0.2% in July 2022. This followed a fall of 0.6% in June 2022.
The services industry was the primary driver of this slightly positive monthly growth in July 2022. Information and communications technology grew by 1.5% and was the largest contributor to the services growth in the UK in July. More specifically, telecommunications and computer programming, consultancy and related activities drove the sector’s growth. The UK’s technology industry is also a key foreign direct investment (FDI) sector, bringing in capital investment from abroad. In contrast to the UK’s service industry, production and construction industries both continued to fall further in July, having already declined in June.
Analysis from PwC suggests that the UK economy will grow between 3.1% and 3.6% in 2022. The international consultancy also predicts low or even negative growth for the country in 2023 and 2024.
UK FDI likely to fall in 2022
Following a 25% decline in inbound FDI projects between 2019 and 2020, the UK recovered quickly with 1,216 inward FDI projects in 2021. This represented a 47% increase compared with the previous year. The UK also exceeded pre-Covid-19 levels in 2021, with a 10.1% increase in project numbers compared with 2019.
However, this growth is not expected to continue into 2022. FDI projects numbers are likely to decline amid growing inflation levels and lingering global supply chain issues, although not to the same extent that investment levels dropped in the fallout from Covid-19. This continues a period of FDI volatility since 2016 when Brexit was agreed.
Of the 1,216 FDI projects recorded in the UK in 2021, approximately one-third were in London. In comparison, Glasgow – the UK’s second most popular inward FDI destination – accounted for 2.1% of the country’s overall projects.
Reducing London’s dominance was the main aim of former Prime Minister Boris Johnson’s flagship 'levelling up' policy, which was introduced to address economic inequalities across the UK. It was a key theme of the Conservative Party's successful 2019 election manifesto, although the plan to deliver its white paper was delayed several times before its release in February 2022. Following Johnson’s departure, the future of the levelling up policy is uncertain, with some claiming that Truss will let it fall by the wayside.
Unemployment hits record low, but economic inactivity and job vacancies remain high
The UK unemployment rate hit a record low in the period between May and July 2022. Unemployment levels decreased by 0.2 percentage points from the previous quarter to reach 3.6%. This is the lowest figure recorded since the period between May and July 1974.
However, the national employment rate for people aged between 16 and 64 years dropped to 75.4% during May to July 2022. This represents a decline of 0.2 percentage points compared with the previous quarter. The UK employment rate is also yet to reach pre-Covid-19 levels. This is in contrast to many of the world’s leading economies including Japan, Germany, France, Italy and Canada.
In addition, the national economic inactivity rate rose to its highest level since 2017 at 21.7%. The UK inactivity level increased by 0.4 percentage points between May and July 2022 from the previous three-month period. The Office of National Statistics attributes this growth to those inactive because they are students or long-term sick.
The number of job vacancies recorded in the three-month period from June to August 2022 in the UK was 1.3 million, a decrease of 34,000 compared with the previous quarter. Despite this being the largest quarterly fall since June to August 2020, vacancy levels remain historically high, and employers are struggling to find staff. Experts have warned that labour shortages are restricting economic growth and driving up inflation.
UK pay is also struggling to keep up with the cost of living crisis. The annual growth rate for nominal earnings excluding bonuses increased by 5.2% in the three months between May and July 2022. However, when adjusted for inflation, real earnings declined by 2.8%. Despite an extremely tight job market driving wage growth, soaring inflation has left employees worse off in real terms.
Is the UK set for another winter of discontent?
The UK has had one of the worst-affected economies by global inflationary pressures. Its CPI remains high, and this is impacting economic growth. The government’s attempts to quell spiralling costs of living resulted in a drastic mini-budget deemed unrealistic by investors and unpopular by the British public.
Households are being hit with rising costs and slower-than-inflation wage growth. This means they are seeing real earnings fall, making most people economically worse off. Economic growth has been flat and there is the real possibility a recession could hit. The winter will see increased energy cost pressures as temperatures fall.
Some good news is that the unemployment rate is at a record low, but job vacancies rates remain high and one in five people in the country are economically inactive. Additionally, inward investment has been volatile since the Brexit vote in 2016, although the UK does remain an attractive destination for FDI.
The UK government has to find a way to implement policies that lower inflation and get investors onside. If it does, then it may just be possible to see some light at the end of a very long tunnel.
