Economists are cautioning that the UK economy could be plunging towards a steep recession and a surge in unemployment if interest rates reach the 6% threshold that financial markets anticipate.
There’s growing pressure on household budgets as mortgage expenses climb, while escalating corporate bankruptcies, particularly among smaller firms which make up the majority of employment, suggest that these businesses are finding it challenging to manage increased costs of borrowing.
The UK has managed to withstand the cost of living crisis to date, avoiding a recession. The International Monetary Fund even recently uplifted its growth forecast for the country. However, economists are now apprehensive that the Bank of England (BOE) might be compelled to cause a downturn to contain inflation, which is decreasing at a slower pace than Governor Andrew Bailey and his team had anticipated.
Financial markets are anticipating another hike of a quarter point next week to 4.75%, with the expectation that rates could climb to 5.75%, or even 6%, next year. This would represent a 22-year peak and could add an additional £250 ($321) per month to average mortgage payments, as estimated by the Resolution Foundation. This would be five times greater than the savings earned from the recent fall in energy prices.
Neal Hudson, a real estate market analyst at BuiltPlace, has estimated that with interest rates at 6%, homeowners would be devoting nearly a quarter of their income to cover mortgage expenses, a considerable increase from the 17% in 2020. For individuals who need to remortgage at these heightened rates or those on tracker arrangements, the cost of living crisis will likely be felt more intensely than the effects of the previous energy price surge.
“If the Bank elevates rates to the extent that the markets are predicting, a recession is unavoidable,” says Gerard Lyons, chief economist at wealth management firm Netwealth. Erik Britton, CEO of Fathom Consulting, concurs: “If rates reach 6%, a recession is inevitable.”
Mortgage borrowers are already feeling the strain from the dozen rate hikes enacted by the BOE since 2021, which have pushed the benchmark lending rate to its highest level since 2008. Coupled with financial market unrest, this has escalated the cost of both mortgages and business loans. Both Britton and Rob Wood, chief UK economist at Bank of America Merrill Lynch, suggest that the corporate sector is on the brink of a critical shift.
Their concern is that an increase in insolvencies will result in a rise in unemployment and a subsequent wave of job cuts as firms currently stockpiling labour due to worker shortages start to let employees go. Consumer spending would plummet under these conditions, and a downturn would be certain. As people who can no longer afford their mortgage payments become forced sellers, house prices would drastically fall.
Megan Greene, who will be joining the BOE’s rate-setting committee next month, conveyed to the Parliament this week that a sudden cessation to “labour market hoarding…would have substantial repercussions on consumer confidence and spending, potentially inciting a recession.”
As firms lay off retained staff, unemployment would see an abrupt increase, according to Raghuram Rajan, former chief economist of the International Monetary Fund and finance professor at the University of Chicago Booth School of Business.
“This would result in higher unemployment than desired, as these factors interact in a non-linear manner. Unemployment is detrimental to both demand and housing, as jobless workers unable to meet their mortgage payments are forced to sell.”
While this paints a bleak picture, it’s a situation that Britain might successfully circumvent. The majority of economists believe that interest rates will not exceed the levels currently factored into the market. Present investor concerns were sparked by a labour market report revealing inflationary pressures to be stronger than anticipated, and upcoming data in the next few weeks could potentially be less severe than expected.
Nevertheless, this situation puts Prime Minister Rishi Sunak in a challenging position ahead of an anticipated election next year. Even though he agrees with the BOE’s aim to control surging prices, the harsh ramifications of a recession could adversely affect his standing in the polls.
Increases in interest rates are nearly as limiting to the government’s capacity to provide for its citizens as they are to households. The Liberal Democrats have proposed a £3 billion mortgage support fund to assist struggling borrowers. However, each percentage point rise in rates adds an extra £20 billion to the government’s debt servicing costs. With a mere £6.5 billion in reserve as of March, Chancellor Jeremy Hunt has no wiggle room without violating his financial regulations.
Even in the absence of a recession, the Bank of England’s projections for the UK’s medium-term growth suggest a sluggish annual expansion of just 1%. This pace is so modest that living standards in the UK are expected to fall behind those in the G-7 nations.
