The UK economy has officially entered contraction territory, with GDP figures released this morning confirming a 0.3% quarter on quarter decline. The numbers, worse than the Treasury’s own doomsday forecast, lay bare the collateral damage from the escalating conflict in the Middle East. Oil prices have spiked 15% in the past fortnight, pushing inflation expectations dangerously above the Bank of England’s 2% target. The gilt market is already pricing in a 50 basis point hike at the next Monetary Policy Committee meeting, a move that would choke off any remaining growth momentum.
Jeremy Hunt, the Chancellor of the Exchequer, is reportedly convening an emergency Cobra meeting this afternoon. Sources inside the Treasury say that the fiscal headroom, already slim after the Autumn Statement, has evaporated entirely. With borrowing costs rising and corporate tax receipts falling, the government faces the grim prospect of breaching its own fiscal rules before the year is out.
The real concern is capital flight. Foreign investors have been net sellers of UK gilts for six consecutive weeks, driving yields on the 10-year benchmark above 4.75%. The pound has shed three cents against the dollar since the start of the month, adding to import costs and further squeezing household budgets. This is a classic balance of payments crisis in the making.
Meanwhile, sectors dependent on consumer confidence are haemorrhaging jobs. Retail sales dropped 1.2% in March, hospitality is seeing cancellations, and the construction PMI has plunged to its lowest level since the 2008 crisis. The war in Iran has disrupted supply chains for everything from semiconductors to fertiliser, but the structural weakness in the UK economy predates this conflict. We have been living off borrowed time and low interest rates for too long.
The Chancellor’s options are unenviable. He can cut spending and risk a recession deeper than the one we are already in, or he can borrow more and test the markets’ patience further. There is no third option. The time for fiscal prudence was five years ago. Now we are paying the price for successive governments’ addiction to cheap money.
Make no mistake: the market is now the disciplinarian. If the Chancellor does not produce a credible plan to stabilise the public finances, the bond vigilantes will do it for him. And they will not be gentle.
