At a seminar organised and hosted by Eton Bridge Partners at London’s Café Royal on Wednesday 22nd March, David Smith began by describing the shocks and challenges that have hit the economy in recent years. This includes the global financial crisis, Brexit and Donald Trump’s trade wars, the pandemic, and the Russian invasion of Ukraine. Each one, he said, having a lasting impact.

The end of an era?

The financial crisis meant the end of the norm of 2% productivity growth, which had persisted for decades, even centuries. The near stagnation since then had been associated with prolonged weakness in real wages and slower economic growth. The Brexit referendum snuffed out the recovery in business investment, and the pandemic hit it further, so it is at the same level today as seven years ago. The two are related: higher levels of business investment being necessary to boost productivity.

The COVID effect

The pandemic has had an impact on the size of the workforce, of which more below, but the biggest effect has been on government debt, Smith noted. It was 80% of gross domestic product (GDP) before the pandemic and is close to 100% now, thanks to £400-500 billion of additional debt. Much of this was in the form of direct support to the economy, including the furlough scheme.

Inflation sending shock waves

The fourth of these shocks, the Russian invasion, gave us very high inflation, announced at 10.4% on the morning of the seminar, after an unexpected rise. Analysts had expected inflation to drop below 10%. The lasting impact of double-figure inflation is yet to be seen, but it has meant that we have broken decisively out of the long period of near-zero interest rates that followed the global financial crisis.

As for inflation, it is still heading for a very sharp fall this year despite February’s upward surprise. “Base effects” – comparisons with the high prices of a year earlier – will automatically reduce inflation. Most prices will stay at their new higher levels, though energy bills should come down, but inflation will fall. The rise in inflation made a rise in interest rates inevitable, and the Bank of England duly obliged by raising Bank Rate from 4% to 4.25% on March 23rd. There is a good chance that this will be the peak in interest rates, Smith said.

Is there more to come?

Was there now a fifth shock in progress, with renewed worries about the banking system, following the collapse of Silicon Valley Bank in America and the forced takeover of Credit Suisse by UBS in Switzerland? Smith said that we should believe central bankers and regulators when they say that banks are stronger and better capitalised than they were in 2008. But banking is all about confidence, and it will be important in coming weeks to maintain confidence and limit the damage. A situation of sharply falling bank share prices and doubts among depositors about the safety of banks is not one that we want to see repeated.

What is the outlook for the economy?

The global economy was hit quite hard by the inflation shock and for the UK it has meant that there has been no growth over the past 12 months. The economy has stagnated. It is good news that both the Office for Budget Responsibility (OBR) and the Bank of England now say that there will no technical recession this year, partly thanks to huge government energy price support.

A tight labour market

With the unemployment rate at just 3.7% and roughly as many job vacancies as unemployed people, is also helping, although the UK workforce is probably 1 million smaller than it could have been expected to be by now at the start of the pandemic. Some of that is due to Brexit, most is due to rising economic inactivity, particularly among older workers. Getting them back into employment is a significant challenge, particularly with many facing long-term health problems. The outlook for the economy is broadly flat, though within that some sectors will do better than others. The labour market should get less tight, easing recruitment difficulties, though competition for talent will remain intense.