The UK economy is facing a heightened risk of recession as inflation and mortgage rates soar, according to experts. The latest figures from the Office for National Statistics (ONS) show that the Consumer Prices Index including owner occupiers’ housing costs (CPIH) rose by 8.9% in the 12 months to March 2023, down from 9.2% in February. However, this is still well above the Bank of England’s target of 2%, and the highest annual rate since 1991.
One of the main drivers of inflation is the rising cost of housing and household services, especially electricity, gas and other fuels. The ONS said that these items contributed 2.6 percentage points to the annual CPIH inflation rate in March 2023. This reflects the global surge in energy prices, as well as the end of the price cap on standard variable tariffs in April.
Another factor that is pushing up inflation is the rising cost of food and non-alcoholic beverages, which added 1.4 percentage points to the annual CPIH inflation rate in March 2023. The ONS said that this was mainly due to higher prices for meat, bread and cereals, milk, cheese and eggs, and oils and fats. The food inflation rate was 16.5% in May 2023, according to Kantar, although it eased slightly from 17.4% in April.
The high inflation rate has implications for mortgage rates, as lenders tend to pass on the increased cost of borrowing to their customers. According to Ideal Home, mortgage rates have risen by an average of 0.5% since January 2023, and some experts predict that they could rise further if the Bank of England decides to raise the base rate to curb inflation. The base rate is currently at 0.25%, but some analysts expect it to reach 1% by the end of 2023.
A higher base rate would mean higher interest payments for millions of homeowners with variable or tracker mortgages, as well as those who are looking to remortgage or buy a new property. According to Moneyfacts, the average two-year fixed rate mortgage for a 75% loan-to-value (LTV) ratio was 2.31% in June 2023, up from 1.81% in June 2022. For a £200,000 mortgage over 25 years, this would mean an extra £59 per month or £708 per year in repayments.
The combination of high inflation and high mortgage rates could put a strain on household budgets and dampen consumer spending, which is a key driver of economic growth. Some economists warn that this could lead to a recession, which is defined as two consecutive quarters of negative growth. According to Capital Economics, if interest rates hit 6%, which is still below their historical average, the UK economy could shrink by 4% in 2024.
The UK economy has already been hit hard by the Covid-19 pandemic and Brexit-related disruptions, which have caused supply chain problems and labour shortages in various sectors. The ONS said that the UK gross domestic product (GDP) grew by only 0.4% in the first quarter of 2023, down from 1% in the previous quarter. The Bank of England expects GDP to grow by 5.5% in 2023 and 4% in 2024, but these forecasts are subject to uncertainty and could be revised down if inflation and mortgage rates continue to rise.
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