News from the ONS early Friday morning revealed that the Gross Domestic Product rose 0.2% in Q2 of 2023. This figure beat expectations of 0.1% pencilled in by the Bank of England as well as the economic consensus. This comes in the wake of interest rates being hiked to their highest level since November 2007, at 5.25%, to combat inflation levels not seen since 1990. These are a continuation of the string of economic complications that have risen as a result of the Covid 19 pandemic and have created a relatively foregone macroeconomic environment.
The Bank stated it was committed to ‘doing what it takes’ to squeeze high inflation, suggesting that high borrowing rates will persist for some time in order to bring down sticky high inflation. In order to not let currently stubborn inflation become chronic and its symptoms to crystallise, the Bank stated it would ensure borrowing costs remain “sufficiently restrictive for sufficiently long to return inflation to the target.” Despite expectations that rate hikes would slow as inflation began to cool, with the Chancellor and the Government seemingly behind the Central Bank, the aforementioned growth in GDP may serve as a signal to resume aggressive rate hikes.
However, underlying economic data suggests that the direction this mission puts the Bank of England in may have wider negative implications for the economy. The crucial factor when considering the impacts of these rate hikes is the time lag that monetary policy usually has in enacting change in the economy. It is often recognised in economic consensus that it takes around “18 months for the impact of a single rate increase to fully seep through into spending patterns and prices” and thus, it can be argued that only an interest rate of 0.5%, in February 2022, has been priced into spending patterns and prices. Furthermore, the original supply-side inflation, seen in the large rise of commodity prices, has largely subsided with wholesale prices falling since the start of 2023, suggesting that current inflation is largely fueled by demand. In regards to demand, the rise in GDP could actually be attributed to the exceptional circumstances of good weather and an increase in live events and the bank holiday rather than sustained growth. Even when examining household final consumption expenditure directly, which reported a 0.7% growth quarter on quarter, the largest contributors were energy (gas) and transport costs. In light of this underlying data, it would seem misadvised to continue raising interest rates, where the first stress fractures in the economy are already beginning to show. The Resolution Foundation think tank forecasts that 1.6 million mortgage holders will come to the end of cheaper fixed-rate deals this year, adding about £2,300 to a typical borrower’s annual repayments. Mervyn King, an ex-BOE governor, has also warned that continued tightening of monetary policy could “generate both a recession as well as a sharp fall in inflation.”
Thus, whilst it may be conventional wisdom to perceive this recent rise in GDP as a signal to which interest rates must be hiked, underlying economic data suggests otherwise. The economy at the moment is one that is not being driven by consumers with excess disposable income, and tightening of monetary policy is likely to result in what is seemingly avoidable further economic strain.
Written by Sarp Basaran
