What's next for the UK economy?

"The thing that saved Britain from a deeper recession towards the end of last year was the savings built up during the pandemic. We didn’t get a boom from those savings, probably because of the spike in energy prices, but it did prevent a deeper recession.

"But it is clear the economy is stagnating as the impact of tighter monetary policy takes its toll.”

Azad Zangana, chief European economist at Schroders, says a persistent problem for the UK economy in the months to come is likely to be held back by two factors: the impact of higher interest rates depressing demand in the real economy, and the persistence of higher inflation despite the rate rises.

Zangana says this all paints a “challenging” picture of the UK economy, as he expects inflation to fall to around 5 per cent this year, around twice the 2.7 per cent level that is forecast by the Office for Budget Responsibility for this year.  

Rates and measures 

Although the UK and global economies appear to have weathered the impact of interest rate rises better than had been forecast by some policymakers, the biggest negative impact from these rises could be yet to be felt, according to Bartholomew. 

Economic theory posits that there is a delay of between 12 and 24 months between rate tightening and the impact being felt on the real economy.

If that timeframe holds consistent, then the negative impact of rate rises has yet to actually be felt in the economy. 

Zangana's view is that consumer spending will decline as this year progresses and mortgage rates rise. He says that rather than there being a big, immediate shock from rates rising, the impact is spread over several years in the UK as around 88 per cent of mortgage holders are on some form of fixed rate. 

He contrasts that with 2012, a period in which around 70 per cent were on variable rates of some kind. 

So for this reason, he says the impact, while negative, will be less marked than in the past. He says that in southern European countries, variable rate mortgages are much more common than in the UK, so the impact of higher interest rates will be much more sharply felt there. 

In contrast, he notes in the US multi-decade fixed rate mortgages are common, so the impact of higher interest rates is much more muted with regards to its impact on consumer spending. 

He views the UK mortgage market as being in between the two extremes of the US and southern Europe. 

It is clear the economy is stagnating as the impact of tighter monetary policy takes its toll.Luke Bartholomew, Abrdn