UK economy vulnerable to consumption-led recession

The UK has long been reliant on consumer spending for its growth, which looks increasingly fragile in the wake of its vote to leave the European Union, former Bank of England (BoE) officials warned today (August 2).

Consumption is likely to be “squeezed” in the months ahead as inflation runs ahead of wage growth, former BoE deputy governor John Gieve said during a panel discussion hosted by Fathom Consulting.

Charlie Bean, another former BoE deputy, noted that given the UK’s very low savings ratio, “it is not implausible you could get a sharp slowdown” if people started saving more. The problem is compounded by growing levels of consumer debt, which act as an “amplifying mechanism”, he added.

Fathom’s lead economist, Erik Britton, gave a typically gloomy assessment of the UK’s prospects as he presented the firm’s outlook for the next few years. “The tide is starting to turn,” he said, observing the unexpectedly strong consumer sentiment since the Brexit vote is likely to give way under the weight of higher inflation.

Meanwhile, growth in productivity is depressed and exporters are not expanding volumes, despite the weak pound. While investment has held up, in the past it has tended to fall with a lag after consumption drops. “It is rather a bleak outlook,” he said.

Fathom is predicting a technical recession in the next two years, with the baseline forecast suggesting it could come as soon as the end of 2017.

That leaves the BoE with a difficult job. The central bank is currently looking past above-target inflation, which has been driven largely by exchange rate effects, but it has little room to deal with slumping growth.

“I think central banks are out of ammunition,” Gieve said. He warned it is proving very difficult to dislodge inflation expectations from low levels, as the case of Japan highlights, making it hard to return rates to more sustainable levels.

Zombie firms

Fathom economists believe the UK should employ helicopter money to boost inflation, which would enable the BoE to raise rates; in turn, forcing the large group of “zombie firms” that are barely meeting interest payments to close up shop. This could allow capital to be reallocated to more productive areas, helping to solve the UK’s productivity puzzle.

Bean was sceptical, saying helicopter money was not the “magic bullet” that Fathom believed it to be. He warned the policy would have to be permanent for it to work, but there was no mechanism to credibly commit to such a thing.

Gieve warned the audience not to assume rates would necessarily remain stuck at close to zero. He noted political risks were high – should the UK’s minority government fall, the country could plausibly see a further drop in sterling and a loosening of fiscal policy by the new government, forcing the BoE to make rapid rate hikes.

The former deputy was doubtful such an outcome was desirable, although “it would definitely have a shake-out effect”, he said, referring to the likely destruction of many zombie firms.