Explainer: Liz Truss inherits Britain’s economy heading into recession as new PM

People walk across the Millennium Bridge with the City of London’s financial district seen behind, amid the coronavirus disease (COVID-19) pandemic, in London, Britain January 20, 2021. REUTERS/Hannah McKay

LONDON, Sept 5 (Reuters) – Britain’s next Prime Minister Liz Truss will face an economy set to slip into a long recession later this year, with inflation at its highest level in 40 years and limits on options to revive growth.

Here is a summary of the main issues facing Truss, who won the keys to Downing Street on Monday by coming first in the Conservative Party leadership race.

INFLATION

At 10.1% in July, Britain had the highest annual inflation rate among the advanced economies of the Group of Seven. Forecasters expect this to rise further, with Goldman Sachs saying it could exceed 20% early next year if gas prices do not fall.

Heavy reliance on imported gas and a rapidly weakening currency partly explain Britain’s inflation problem.

The pound has fallen around 8% against the dollar in the last three months alone – a slightly weaker performance than the euro – making energy imports denominated in dollars even more expensive.

NARROW LABOR MARKET

The Bank of England is concerned about inflationary pressures being generated domestically due to a tight labor market, where staff shortages following Brexit and the COVID-19 pandemic are in some cases sharply increasing jobs. wages.

Official data shows 49,000 fewer EU-born workers in Britain than in mid-2019, while the number of people listed as inactive due to long-term illness hit a high of 19 from 2.39 million in June, up about 300,000 since before the pandemic.

However, there are some signs of a cooling in demand for workers. Job vacancies, which hit a record high of 1.299 million in the three months to May, began to decline as the number of unemployed rose in June for the first time in 17 months.

TAX CUTS? SPENDING INCENTIVES?

Truss promised to cut taxes, starting with a reversal of an increase in Social Security contributions and a suspension of so-called green levies on electricity bills. Economists have warned that a big injection of cash into consumers’ pockets could make Britain’s inflation problem worse.

In addition to the risk of fueling inflation, tax cuts or higher spending would put additional pressure on the UK budget deficit at a time when public debt is close to 100% of economic output.

NO BANK OF ENGLAND RESCUE

Normally, a central bank anticipating a recession would cut interest rates, but the BoE has other concerns, primarily the risk that surging inflation will create a wage-price spiral that could weigh on the economy for years. . Markets expect the BoE to raise the discount rate to 4.5% next year from 1.75% currently. Most economists see a lower peak.

The BoE also plans to start selling some of the bonds it has bought since the 2007-2008 global financial crisis, another form of monetary policy tightening.

FORWARD CHANGE FOR THE BOE

Truss said in July that she wanted to set “a clear direction” for monetary policy and review the BoE’s mandate, raising concerns among investors about central bank independence. One of its proponents questioned whether the BoE should retain its exclusive power to obtain interest rates.

On Sunday, Truss said she was a “big believer” in the independence of the Bank of England.

Written by William Schomberg and Andy Bruce; Editing by Alexander Smith

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