Finance

Sunak's Solo Success: Halving UK Inflation Amid Economic Challenges

(Bloomberg) – The UK has grappled with intense economic pressures as inflation soared to a 41-year peak, but Prime Minister Rishi Sunak may have just secured a vital win. According to a Bloomberg survey of economists, Sunak is poised to proclaim a significant triumph over the cost-of-living crisis, with inflation rates set to plummet to approximately 2.1%, aligning with the Bank of England’s target and marking the lowest rate since July 2021.

In the wake of managing only one of his five ambitious objectives at the outset of 2023, Sunak's focus now turns to the arduous task of convincing the British public that he is responsible for these improved economic metrics from the Office for National Statistics. By positioning Britain as “turning a corner,” Sunak can argue that with the fast-paced recovery from recession, and an upswing in living standards, the nation has reasons to be optimistic.

The Battle Against Inflation

A year and a half earlier, the UK confronted the harshest price shock in comparison with other leading developed economies, when inflation touched an unprecedented high of 11.1%. The rate subsequently plunged at a pace unseen since the 1970s, potentially clearing the path for a decrease in interest rates from 5.25% as early as the next month. Such a move would alleviate financial strains for mortgage borrowers and businesses alike.

The Political Landscape

Current opinion polls indicate the ruling Conservative Party lagging significantly behind the Labour Party, trailing by approximately 20 points. Following a series of defeats in local elections, Sunak, along with Chancellor of the Exchequer Jeremy Hunt, is banking on engendering a "feel-good factor" among voters as the nation anticipates the upcoming general election.

Chancellor Hunt has expressed confidence in their economic strategy, stating during a Westminster event, "We are winning the battle against inflation." He highlights collaboration with the Bank of England to navigate the nation to a "soft landing" many assumed improbable.

However, the legacy of economic pain persists. While Sunak and Hunt focus on the recent positive turnover – slowing inflation and elevating real wages – Labour accentuates existing levels of financial well-being. Real wages remain deflated compared to pre-financial crisis benchmarks, indicating that earnings still fetch less purchasing power than in 2007.

Moreover, despite inflation's anticipated return to the target levels, the price level escalates about 23% from the commencement of the present parliamentary term in 2019. London School of Economics reports denote a 30% hike in food prices over the last three years, a figure that took 13 years to achieve prior to 2021.

The Economic Mirage

When delving into the country's GDP, a different narrative emerges. While the nominal GDP appears bolstered by a growing populace, GDP per capita presents a more modest account of economic health. Although the relentless seven-quarter decline concluded with a modest recovery early this year, GDP per capita lingered 0.7% below figures from the previous year.

Then, there's the discourse regarding tax cuts. Since November, Hunt has reduced national insurance, a significant payroll levy, by 4 percentage points. Yet, this £20 billion ($25.4 billion) concession is overshadowed by fixed thresholds, which ensure the general tax burden keeps escalating. Hunt concedes that while households may feel a temporary uplift this year, financial challenges await thereafter.

Public Sentiment and Labour's Growing Influence

Public favor has increasingly tilted toward Labour for economic stewardship, following the tumult caused by former Prime Minister Liz Truss's ill-fated "mini-budget." This shift interrupts a historic political pattern in Britain. Recent YouGov surveys reveal that the public’s trust in Labour to safeguard the economy supersedes confidence in the Conservatives, with an even more pronounced advantage for Labour in managing public services.

The BOE and Inflation Dynamics

Attribution for falling inflation also complicates claims of Conservative success, given that such responsibility primarily lies with the Bank of England (BOE). Economist Thomas Pugh from RSM UK suggests that an inflation rate settling around or below 2.1% might justify the BOE initiating interest rate cuts this June.

Underpinning the government's claims of economic recovery are statistics revealing real wages rising at their most robust rate since September 2015, if pandemic-related furlough payments are disregarded. The country's economic output has correspondingly rebounded significantly, reaching unprecedented levels after a brief recession in 2023.

Delving deeper into household economics reveals a decline in energy bills last month, hitting a two-year nadir, with anticipations of further drops by July. Concurrently, food inflation has plummeted, offering some solace to lower income families that endured the deepest impacts of the inflation surge. The BOE projects a quicker improvement in living standards, based on post-tax real household income, than the annual average preceding the pandemic.

Investors and economists estimate a 50% likelihood of the BOE cutting rates as soon as June. Yet, there lingers apprehension over persisting price pressures, notably within the services sector, where inflation may maintain a rate above 5% in April. Such concerns linger despite predictions of a more moderate 2.1% increase for overall CPI inflation.

The Potential Rate Cut and Beyond

Several household expenses are indexed to historical inflation figures, such as mobile phone contracts, which underwent review in April. Similarly, the 10% uplift in the minimum wage that month could have spurred price increases in sectors like hospitality and retail. Deutsche Bank AG has estimated that services inflation basket adjustments could affect approximately 15% due to these engagements.

As the BOE's rate decision approaches on June 20, one more inflation report will materialize. Next month's wage data could disrupt rate reduction plans, especially since the near-10% increase in minimum wages' impact on broader salary structures is not entirely clear. Economist James Smith from ING emphasized, "April is just this very volatile month because there's so many different areas that are resetting their prices, and wage growth has been quite high."

Projections suggest that following a dip to about 1.9% in the second quarter, consumer price growth will rebound to 2.2% by year's end. Yet, neither BOE forecasts nor Bloomberg economist surveys foresee inflation re-escalating to 3%. Assuming inflation stabilizes around the target, predictive models suggest the likelihood of the BOE trimming rates to 4.5% by the conclusion of 2024.

Final Thoughts From Government Officials

A government official voiced a palpable sense of relief that the UK economy seems to be reestablishing its pre-pandemic normalcy. With COVID-19 and the immediate inflation shock transitioning to the past, the critical inquiry remains whether the electorate will resonate more with recent short-term advancements or the enduring long-term economic decline.

Acknowledgments and Source

This report incorporates contributions from Harumi Ichikura and is officially published by Bloomberg L.P. For more information, please visit the Bloomberg website.

As inflation gradually returns to normal levels and the Bank of England negotiates its next move, eyes will be fixed on the economic horizon. Policymakers, economists, and the public alike stretch their gaze to determine if the descent from economic turmoil will restore faith in the current government or signal a time for change.

Ultimately, the ability of the Conservative Party to harness the narrative of economic recovery and convince the public of its fiscal competency will be crucial. With the general election looming, both the Conservatives and Labour Parties brace for a showdown where economic credibility could tip the scales.

©2024 Bloomberg L.P.