There was only ever an outside chance that the Conservatives would win the next general election after the tumultuous period that resulted in Rishi Sunak becoming prime minister last October. The events of the past week mean the prospect of a fifth Tory victory is now vanishingly small.
Ironically, things started so well for the government. On Tuesday, the chancellor, Jeremy Hunt, luxuriated in the praise bestowed on the UK from the International Monetary Fund as it upgraded its growth forecasts for the economy.
Kristalina Georgieva, the IMF’s managing director, came bearing three gifts. She said the Fund was no longer predicting a recession for the UK this year; she confirmed that the UK would no longer be the worst-performing country in the G7: and she praised Hunt for his handling of the economy.
With the following day’s figures for the cost of living expected to show a sharp drop in the annual inflation rate, a narrow path to victory for Sunak and Hunt was just about discernible. Optimism lasted less than 24 hours.
At 7am on Wednesday the Office for National Statistics published figures showing that while inflation had indeed fallen, it had not dropped by nearly as much as the financial markets had been anticipating. Even worse, core inflation – a cost of living measure that excludes items such as food and fuel – rose.
Previously, the City had thought that interest rates were at or close to a peak. Twelve successive increases have taken the official cost of borrowing from 0.1% to 4.5% and the markets were split between those who thought the Bank of England would leave them unchanged and those who thought one more quarter-point rise would be deemed necessary to bring inflation back to its 2% target.
The mood has now changed. As far as the markets are concerned, the peak in interest rates will not be 4.5% or 4.75% but 5.5%. In an echo of last autumn’s turmoil, the yield (or interest rate) on government bonds rose to reflect the worse-than-expected inflation news. Bond yields affect the cost of servicing mortgages, and lenders responded by raising home-loan rates and pulling some products from the market.
This is all terrible news for Hunt and Sunak. The chancellor said he would support any anti-inflationary action the Bank’s monetary policy committee might need to take even if it meant a recession. Even so, Hunt will be fully aware of the dangers – both economic and political – of interest rates being kept higher for longer, and he has every reason to be hopping mad with Threadneedle Street.
There are two things every student of economics knows about monetary policy: it takes time to have an effect and it is a blunt instrument. The art of setting interest rates is to be ahead of the game: to raise rates before inflationary pressure starts to appear and to cut them before the economy weakens by too much. Having been slow to tighten policy, there is now a strong risk that the Bank will be guilty of overkill and be too slow to loosen.
Yes, the Bank can squeeze inflation out of the economy but only by weakening the economy and pushing up unemployment. The UK narrowly avoided recession in the winter just past; it may not be so lucky in the winter to come.
The resilience of the economy over the past six months has been due to a number of factors: oil and gas prices have fallen, some of the excess savings built up when spending opportunities were limited during the pandemic have been drawn down; the government has subsidised energy bills; and mortgage rates have dropped. A higher population due to net migration has also helped to boost growth. Hunt was hoping that the continuation of this better news on the economy would eat into Labour’s healthy opinion polls lead.
If, so the thinking went, by the time of the next election inflation was markedly lower and wages were rising faster than prices, then the Conservatives would have a narrative to sell, even if not a stunningly persuasive one.
With inflation still high, Downing Street is now reportedly drawing up plans for retailers to introduce voluntary price caps on basic food items such as bread and milk to help tackle the rising cost of living, according to the Sunday Telegraph.
Sitting governments can play it one of two ways on the economy. In good times they ask the question Ronald Reagan put in his presidential debate with Jimmy Carter in 1980: do you feel better off than you did last time you voted? When the answer is yes, as it was for the Tories in 1987 and as it was for Labour in 2001, the opposition struggles to get a hearing.
But Hunt knows that voters are not going to be better off by the time of the next election – no matter how long it is delayed – than they were in December 2019. He hopes the Reagan question will not be relevant at the next election, although that is almost certainly wishful thinking. Labour will be asking voters whether they feel better off not just over the past five years but over a period of Tory rule stretching back to 2010.
Hunt’s back-up plan involves focusing on the economy’s better performance under his stewardship and to ask voters a different question: given the job I have done since taking over from Kwasi Kwarteng, which party do you think will make you better off over the next five years? This is obviously a weaker pitch but it has worked for the Conservatives in the past, most notably when John Major won in 1992.
Polling day is still a long way off and only a fool would write off the Tories completely. That said, last week felt decisive. For Sunak and Hunt to grab victory from the jaws of defeat everything has to go right for the economy. Clearly, everything is not going right.