UK economy: Growth prospects ‘stymied’ as inflation stagnates and interest rates soar

The UK government must take legislative action to tackle troubling inflation and interest rates and allow business growth and productivity to flourish, market participants have argued.

Defying predictions of a slowdown, ONS data released on Wednesday (21^st June) revealed that British inflation held at 8.7% in May. This halts the downward trend for the UK rate, which had fallen every month since peaking at 11.1% in October 2022.

The stagnation means that inflation in the UK remains higher than key international competitors such as the US (4%), Germany (6.1%), and Japan (3.5%). ‘Core’ inflation (not including energy and food costs) also stands at its highest since 1992, while UK debt is now higher than annual GDP for the first time since 1961.

Prime Minister Rishi Sunak has pledged to halve inflation this year ahead of a predicted general election in 2024.

Responding to the troubling figures the following day (22^nd June), the Bank of England (BoE) Monetary Policy Committee (MPC) elected to hike UK interest rates by a shock half percentage point to 5%. A bigger increase than forecasters expected, this is the first time the nation’s base rate of interest has reached the 5% mark since 2008.

Government action needed

According to Andrew Harding, chief executive at the Association of International Certified Professional Accountants (AICPA), the government must act to remedy the troubling economic picture or risk compromising the growth prospects of UK companies.

“Until the problem is dealt with, finance teams are having to prioritise cash management practices over freeing up resources for the investment that will drive innovation and productivity. This will inevitably mean longer term growth prospects are stymied.”

Harding notes that, according to research conducted among AICPA (and partner organisation CIMA) members, there are numerous policy areas where the government needs to focus to bring rates down to “a more manageable level”, adding that “we need a push for higher productivity and to address the underlying causes of inflation”.

A key example of this, Harding explains, is tackling the skills shortages and weak investment “which plague the UK economy”. Reforming the Apprenticeship Levy and policies addressing supply-side issues would be “an excellent place to start”, he adds.

Harding also argues that the government could “provide more certainty” by outlining its business taxation plans for the next two years, enabling businesses to make better investment decisions.

BOE’s ‘lost credibility’

Market participants have also levelled criticism at the BOE in response to June’s unexpectedly substantial interest rate hike. According to Julian Jessop, economics fellow at free market think tank the Institute of Economic Affairs, the move points to the Bank’s “lost credibility”.

“A more credible bank might have been able to leave interest rates on hold today,” he says, arguing that the full impact of previous rate increases has yet to be felt and that there still “good reason” to expect inflation to fall sharply during the remainder of 2023.

“Unfortunately, confidence in the bank is low after a series of policy mistakes, forecast errors and communication blunders. This MPC was forced to raise rates by an unexpected half a point to demonstrate that it is serious about getting inflation back down.”

Similarly, Dr George Dibb, head of the centre for economic justice at progressive think tank the Institute for Public Policy Research, argues that the interest rate rises are “doing more harm than good”, and that “government inaction” has forced the BOE into the drastic measure.

“Instead of further rate rises, we need a more balanced set of policies, including more fiscal policy action, to address the persistence of inflation. This should involve further price support measures to lower energy prices, excess profits taxes to disincentivise excessive price increases, and income support to help smooth out wage adjustments.”