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U.K. financial despairs fixed state and central bank on a crash course

July 5, 2023: In January, with one look on a critical public election in 2024, U.K. Prime Minister Rishi Sunak pledged to halve inflation by this year-end.

At the time, headline consumer price inflation ran at an annual 10.1%. Given that most economists were swelling that this would halve naturally as the shock of soaring energy prices fell away, the pledge seemed like an open goal for Sunak’s Conservative government.

Yet headline CPI in May came in at 8.7%, unchanged from the previous month, while core inflation which excludes volatile energy, food, alcohol, and tobacco prices, increased to 7.1%, its highest rate for 31 years.

Annual average wage growth, excluding bonuses, also accelerated from 6.7% to 7.2% in the February-April quarter, the fastest rate on record. At the same time, the labor market remains hotter than expected, and the U.K. has faced an unusual spike in long-term sickness that has hammered its labor force participation rate.

Therefore, economic growth has all but stagnated, and public debt has reached 100% of gross domestic product for the first time since March 1961.

The Bank of England re-accelerated the pace of interest rate hikes in June, raising the Bank rate by 50 basis points to 5%, further compounding domestic fears of a mortgage crisis and diverging from other major central banks that have been able to either slow or pause rate hikes.

Shaan Raithatha, senior economist at Vanguard, told on Monday that the U.K. is suffering from the “worst of both worlds.”

Andrew Bailey: U.K. economy has turned out to be much more resilient

“We’ve had a U.S.-style labor market shock, particularly the large number of long term sickness that has impacted the supply of labor there, and they’ve had a European-style energy shock emanating from the war in Ukraine,” he stated.

“What is perhaps surprising is that the energy shock in the U.K. was larger than in most mainland Europe.”

Raithatha suggested this could partly be a result of government policymakers being too gradually to step in during the early stages of the energy crisis, and when they did step in, capping energy prices at a higher level than many peers.

“There’s an problem here because the economy is very resilient; we know that the transmission towards mortgages is a bit slower and a bit less effective than we’ve had in the past as well, and so clearly, the Bank has to do a bit more to get inflation under management,” he added.

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