Lehman Brothers was still in business, Gordon Brown was the prime minister and George Bush was US president. The last time the Bank of England held interest rates above 5%, the world economy was very different. There were warning signs, but few could have predicted the severity of what happened next.
Fifteen years later, the Bank again used its September meeting to keep interest rates on hold, bringing to a halt its most aggressive round of rate increases in decades, with rates set at 5.25%, the highest level since 2008. For many, the end of ever-higher rates could not have come soon enough.
Once again there are growing signs of recession. The force of previous rate increases, combined with stubborn inflationary pressures, are running the economies of Britain, the US and the EU into a brick wall. Talk of a “hard landing” after the biggest inflationary shock in 40 years cannot be dismissed lightly.
With inflation still uncomfortably high, the Bank is expected to keep rates at elevated levels for a prolonged period to ensure inflation falls back sustainably to the 2% target set by the government. It is, as Huw Pill, the Bank’s chief economist, put it in a speech in Cape Town last month, a “Table Mountain” strategy.
Life on the plateau is likely to prove tough. There are still millions of mortgage holders yet to refinance to higher rates, in a ticking timebomb for consumer spending over the months to come. Figures from the private sector already show activity collapsing at the fastest rate, outside the Covid pandemic, since 2009.
Little of this backdrop is good news for businesses. Faced with ongoing cost pressures, higher borrowing costs and rapidly fading consumer demand, companies have few reasons to push ahead with ambitious investment plans. What’s more, the government is adding to the instability.
Determined to make a bad situation worse, Rishi Sunak’s decision last week to move the goalposts on the government’s net zero commitments angered business leaders desperate for greater stability. Pulling the plug on HS2 to Manchester – just as the Tories prepare to hold their annual conference in the city – adds yet more instability into the mix.
Elsewhere, Brexit remains a serious headwind for companies, while offshore wind projects are stalled after the government’s botched subsidy auction received no new bids from energy firms.
Juergen Maier, the former chief executive of Siemens UK, is worried. “We’ve experienced the chopping and changing of policies in this country for decades. But this is no longer chop and change. This is chaos,” he told me last week.
“Everybody [in industry] is now sitting and wobbling and wondering. And I tell you what, they won’t be investing in the UK. It’s a disaster for productivity. It’s a disaster for jobs, well-paid jobs. And it’s a disaster for business confidence and investment – and we need exactly the opposite.”
Unlike the crash 15 years ago, most forecasters do not expect a deep or prolonged recession. But without a rapid turnaround in business investment, the likelihood is Britain will be left without solid foundations for recovery. As a consequence, growth is likely to remain anaemic at best for years to come, turning a lacklustre decade after the 2008 financial crash into two decades of limited progress.
Considered key to raising the long-term growth rate of the economy, business investment involves companies spending on plant, machinery, and information and communication technology.
So far this year, investment has held up better than expected, in part because of Sunak’s super-deduction tax break, which expired at the end of March. The government replaced the scheme with “full expensing” for qualifying capital investments, aiming to soften the impact of a rise in corporation tax from 19% to 25% from April. However, despite arguing that it would like to make the policy permanent, the chancellor, Jeremy Hunt, has so far refused to do so because it would break the Conservatives’ arbitrary fiscal rules.
This is short-termism on steroids, placing narrow political priorities over the long-term needs of the economy. Sadly, it is par for the course in Britain’s recent history of robbing from the future to avoid short-term difficulties. And there are no worse culprits than the Conservatives.
For decades, British business has tended to underinvest relative to firms in other leading nations. From 1971 to 2008, capital accumulation contributed one percentage point to output growth a year on average, according to a Goldman Sachs report. From 2009 to 2021, the contribution averaged just 0.2 percentage points.
Brexit unleashing deep political and economic uncertainty added to the reasons for companies not to invest in Britain. With interest rates at the highest levels since 2008, there are renewed headwinds. According to the Goldman report, for every 100 basis point rise in Bank rate, business investment typically falls by 3% over the following 10 quarters. Rates have risen by five times that level, priming Britain for a marked slowdown in spending.
The position contrasts sharply with the US, where Joe Biden is backing companies by ploughing billions of dollars into infrastructure and green technologies through the Inflation Reduction Act, offsetting some of the pressure on business investment after rate rises from the US Federal Reserve. The EU and China are taking similar steps, spending billions of dollars of public money in a subsidy war to pull ahead in the green industries of the future.
Companies rely on political and economic stability to make their investment plans. With high interest rates for a long time to come, looming recession and Sunak pulling the rug from major government commitments, the business investment required to kickstart the British economy is in serious jeopardy.
