UK economy left on ‘knife edge’ as rate hike torrent takes its toll
The British economy saw inflation finally abate in 2023 but could still finish with a recession and more pressure from the full impact of the barrage of interest rate hikes, with experts warning that the economy has been left on a “knife edge” heading into 2024.
Inflation became the key battle ground for both the Bank of England and Prime Minister Rishi Sunak in 2023 as soaring prices threatened to inflict long-lasting damage, sparking industrial action on a scale not seen since the 1970s.
In January, Mr Sunak made it one of his five key pledges to halve inflation by the end of the year.
Charged with the seemingly impossible task to bring inflation back down to its 2% target, the Bank continued its relentless campaign of interest rate increases, which took borrowing costs to levels not seen for more than 15 years.
Homeowners were hit with 14 hikes in a row, with rates reaching 5.25% in August before the Bank hit the pause button as inflation beat a retreat.
Having started the year at 10.1% in January, inflation fell sharply and by October it eased back to 4.6%, allowing Mr Sunak to declare early victory in achieving his goal.
Inflation continued its steep descent in November, dropping to 3.9% as fuel prices fell and increases in food costs slowed.
But Bank governor Andrew Bailey tempered the Government’s cheer, warning that the battle with inflation was far from over, with still a long way to go before coming back down to the 2% target.
Rather than being driven by policy actions, much of the sharp pullback was also largely driven by this year’s lower energy price cap compared with the £2,500 limit set a year ago.
There was, however, some respite offered to households as soaring food prices and energy costs eased back – and as wage growth finally began outstripping inflation for the first time since 2021.
Yet the worst for many was only just being felt, as the Bank’s torrent of rate rises meant eye-watering jumps in mortgage payments as borrowers rolled off fixed-rate deals.
About half of mortgage holders have already moved to new fixed-rate deals since interest rates started rising in late 2021, amounting to more than five million households.
But a further five million homeowners are still due to face higher borrowing costs by the end of 2026, according to the Bank.
“We might have reached the peak of the interest rate cycle, but we’re not out of the woods by a long shot,” cautioned Laith Khalaf, head of investment analysis at AJ Bell.
Thomas Pugh, an economist at audit and consulting firm RSM UK, said that an estimated 1.6 million households are set to remortgage to sharply higher rates in 2024 alone.
He said this will be partly offset by a rebound in real wages, which should help prop up consumer spending.
“Whilst this should be enough to avoid recession, the economy will remain on a knife edge as it won’t take much of an increase in headwinds to tip the UK into one,” Mr Pugh warned.
He is expecting the UK to “endure another year of stagnation” with growth of about 0.1% a quarter for most of 2024.
“It will likely be 2025 before the economy gets back to any significant increase in growth,” Mr Pugh cautioned.
The Bank is forecasting that the UK will swerve recession in 2024, albeit with zero growth pencilled in, while it does not see Consumer Prices Index (CPI) inflation returning to target until the end of 2025.
But the threat of a recession still looms large.