Call me a ‘doomster and gloomster’ if you like – but this is how bad the economy could get

Even without a house price collapse or a sterling crisis, the government is heading for a summer of political discontent

Rishi Sunak seems to be hoping that he can sit tight until autumn (Reuters)

Spare a thought for Rishi Sunak. A few months ago, he was the country’s most popular politician. Now he is in strongly negative territory. In a few months’ time, he could be the most hated man in the country as economic hardship really bites.

But how bad could it get? I thought I was in danger of getting myself labelled a “doomster and gloomster” a month ago when I trailed the idea of double-digit inflation and recession later in the year or next year. Now, even the governor of the Bank of England is saying as much, as the Bank moves to higher interest rates. I suspect, however, that he may be erring on the side of optimism, for several reasons.

First, the war. Western policy is that every upward ratchet in Russian aggression and cruelty must be matched by an escalation in western economic sanctions, which carries risk for us as well as for the Kremlin.

We haven’t yet got to the stage of concerted action against Russian oil exports. There is a “smart” way of doing it: a heavy tax on Russian oil imports which is passed back to Russia in lower export prices. But considerable skill will be needed to make that happen, and to ensure that western consumers don’t take a big hit. And, if we progress to a cessation of gas imports from Russia, the impact on western economies – not just Germany – could be serious as prices of alternative supplies soar.

Second, the sharp fall in sterling in response to the governor’s forecast of difficulties ahead may be a warning of exchange rate difficulties ahead. The dollar rate, at $1.23, is down from $1.42 a year ago and is heading back to the post-Brexit referendum low of $1.14. Even allowing for a global move into the haven of the dollar, confidence in sterling is low and some traders think our currency could be headed towards dollar parity.

This could provoke a vicious circle, as a falling exchange rate feeds inflation which, in turn, squeezes living standards further, adds to recession risk and diminishes business confidence. With a politically weak government haemorrhaging authority and the costs of Brexit affecting trade performance, it is difficult to see an upside. A downside risk is that the prime minister will try to shore up his authority by picking a fight with the EU over the Northern Ireland protocol, triggering retaliatory action from Brussels.

The public discussion of inflation centres on goods and services: the cost of living crisis. A potentially bigger shock could occur in inflated asset markets, especially housing. Rapidly rising interest rates will be a painful surprise to house buyers who haven’t locked in the low interest rates of the past, and we shall soon see distress from overextended borrowers. But the serious action could be in respect of house prices.

Average UK prices (admittedly a slippery concept) rose around 10 per cent in both 2021 and 2022, after a long period of housing inflation which has taken prices in relation to earnings to levels only matched twice in the last 175 years. The average is in the range 8.5 to 9, almost three times the level 25 years ago and way beyond the mortgage affordability of a household on average incomes: hence the collapse in home ownership among younger people. The problem is even worse in London.

House prices are, however, cyclical and have been driven up in the last decade, both by expansionary money policy enabling easy availability of bank loans and by the artificial stimulation of demand through Help to Buy. A hardening of monetary policy will lead to a painful correction, and the question then is how much prices will fall and for how long.

Previous crashes involved a 15 per cent fall in 2008, a 20 per cent fall spread over the 1989-2003 period and falls in the mid-1970s and 1950s. The nightmare scenario for the government is that prices fall by enough to leave large numbers in negative equity, depressing confidence and demand, but not enough to restore affordability for families on average earnings trying to buy a home. The politics of burst housing market bubbles is awful, as John Major discovered.

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Even without a house price collapse or a sterling crisis, the government is heading for a summer of political discontent. The Lib Dems, who are on a roll after the local elections, could unseat Conservatives in seemingly safe West Country constituencies, when by-elections occur in Tiverton and Honiton, and in Somerton and Frome. Labour should win back the red-wall seat of Wakefield.

Boris Johnson will be looking for a sacrificial lamb to offer. Who better than the hapless chancellor next door, whose national insurance increase has added to personal and business burdens at the worst possible time? It is, after all, also his refusal to restore the £20 uplift on universal credit, granted during the pandemic, which is the single biggest blockage to providing relief to those at the bottom of the income distribution, on benefits or low pay.

Sunak seems to be hoping that he can sit tight until autumn. But even friendly business groups like the Chambers of Commerce are calling for urgent action through an emergency budget. They can see that business confidence and the willingness to invest are draining away.

One possibility is that the hero of the pandemic may find himself shunted to a non-job while the prime minister finds another fall guy or fall gal (Liz Truss?) to preside over prolonged economic pain. That may be a kinder fate than staying put and becoming cordially hated.

Sir Vince Cable is the former leader of the Liberal Democrats and served as secretary of state for business, innovation and skills from 2010 to 2015. His podcast ‘Cable Comments’ is available here