U.K.’s Next Prime Minister Will Inherit A Brutal Economic Storm

(Bloomberg) --

The Bank of England just extinguished any hope of a political honeymoon for Britain’s next prime minister.

Whether it’s Liz Truss or Rishi Sunak entering Downing Street on Sept. 6, they will take power in a deepening economic crisis with inflation soaring, interest rates rising and the country weeks away from entering a recession the central bank on Thursday forecast will last for more than a year.

Liz Truss Is On Course for a Collision With UK Economic Reality

It’s a brutal inheritance that is likely to have stark political consequences. Leading a Conservative Party that’s been running the nation for the past 12 years, Boris Johnson’s successor will be under immense pressure to find a fix for the UK’s malaise or risk severe retribution from voters.

Their immediate task will be finding a way to help Britons through a cost-of-living crisis that will see real disposable incomes fall more than at any time in around 60 years. Inflation is forecast to exceed 13% in October, when soaring energy bills are expected to drive millions into fuel poverty.

With the Tories already trailing Keir Starmer’s opposition Labour Party in most surveys, the bleak outlook also has implications for election timing. The next national ballot is due by January 2025 at the latest, though leaders installed by an internal party process -- which will be the case this time -- face a dilemma over whether to seek their own mandate from the public.

Calling a snap vote in the fall might beat the worst of the looming slump but would also risk the new premier being ejected from office as one of Britain’s shortest-serving leaders. An election later could likely mean going to voters during a period of elevated unemployment and peak economic pain -- or with a recovery barely under way.

The recession will begin in the fourth quarter and the economy will see no quarters of growth until well into 2024, the bank said. The total slump will be about 2.1%, similar to the 1990s recession, followed by a glacial recovery.

In the meantime, both Truss and Sunak will likely face questions over whether their economic plans will be able to ease the pressure on Britons. The two candidates face off in a televised debate on Sky News on Thursday, with Truss holding a 34-point lead among Tory party members -- who cast their leadership ballots over the next four weeks.

For Sunak, the former Chancellor of the Exchequer whose resignation last month helped trigger Johnson’s demise, the BOE’s bleak analysis contained further bad news. It suggested the government’s intervention so far -- a multi-billion pound package drawn up by Sunak in May -- would have a limited impact, adding only 0.5 points to GDP at its peak, an effect that quickly fades.

Truss vs. Sunak: Where UK Leadership Contenders Stand on Economy

Truss, meanwhile, is pledging tax cuts to ease cost-of-living pressures and promises a more aggressive pursuit of economic growth. But her plan to borrow more to fund government spending also became more costly with the BOE raising interest rates by 0.5% -- the biggest increase in 27 years -- to 1.75% and signaling its readiness to go further if needed. 

The central bank is also unwinding its quantitative easing program, another upward pressure on borrowing costs.

Truss said the bank’s announcement bolstered the rationale for her approach and that she would use an emergency budget “to get our economy growing.”

But in a thinly-veiled attack on the foreign secretary’s position, Sunak said raising borrowing would put upward pressure on interest rates, creating more pain for mortgage holders and fueling price growth.

After the Bank of England laid bare the realities facing Britain’s next leader, whether Sunak can overhaul Truss’s lead is likely to depend in large part on which candidate Tory party members trust to turn the economy around.

“The bank has acted today and it is imperative that any future government grips inflation, not exacerbates it,” Sunak said. “As prime minister I would prioritize gripping inflation, growing the economy and then cutting taxes.”

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