It’s been yet another week of grim news for the British economy – and it’s increasingly clear that the Bank of England is powerless to cut the base interest rate to help. As The Daily Telegraph reported, investors are now in fact betting that the Bank “will have to raise interest rates as many as three times before the end of the year”.
On Tuesday, swap rates – at which financial institutions borrow from one another – saw their fastest rise since 1992’s Black Wednesday, to 6.3%, up from 5.4% last month. Investec’s Philip Shaw called it “carnage”.
Why the sudden panic?
Inflation data on factory gate prices (PPI) for May were “absolutely appalling”, said Howard Archer at Global Insight. British industry’s input costs rose by 28% year-on-year, while output prices soared nearly 9%, the highest since records began in 1986. Even ‘core’ PPI, excluding food and energy, rose almost 6% as scrap metal prices surged. Then oil joined in with another leap to $134 a barrel. This all adds up to a toxic cocktail that the Bank will worry could “feed through to the shops, stoking already sharp increases in the overall cost of living”, said Gary Duncan in The Times.
Will interest rates go up?
However, Michael Saunders, chief UK economist at Citigroup, said he “doubts the Monetary Policy Committee will hike rates because real incomes are being eroded and the economy is slowing sharply”. And this week has brought yet more signs of a slowdown alongside the inflation bombshell. The housing market has deteriorated further (see below), while industrial and manufacturing production saw annualised gains of just 0.2% and 0.1% respectively. Following March’s 0.5% manufacturing drop, this is “consistent with sustained falls in output”, said Capital Economics.
And while there was slightly more upbeat news from the British Retail Consortium, with annual like-for-like sales in May up 1.9% compared to a 1.5% fall in April, the three-month comparison against last year still showed a 0.5% slide. Even the mighty Tesco (LON:TSCO), which pockets one in every eight pounds we spend, said UK sales growth had slowed in a performance described by Dresdner Kleinwort retail analyst James Grizinic as “muted”.
No surprise then to hear fresh warnings from former Bank of England policymakers Willem Buiter and Sushil Wadhwani that Britain faces a “light form” of stagflation. Add in any rate rises, and things could turn very nasty indeed.
The big picture: oil’s gradual run-up turns into a spike
Until now, the big difference between the latest oil bull market and the oil shocks of the past – the 1973 oil embargo (1), the 1979 Iranian revolution and the 1980 Iran-Iraq War (2&3) and the 1990 Gulf War (4) – was that the rise has been gradual, rather than a spike. Each shock was followed by recession; this time, optimists had hoped the slow rise would give economies time to adapt.
But the latest spike from $80 to almost $140 is near-vertical on the chart and has taken oil past the 1978 record in real terms. The risks of serious fallout – such as 1970s-style slowing growth and runaway inflation – must be rising.