Economic Hindsight: The State of the U.K. Economy post-COVID-19 and Post-Russia-Ukraine War

Economics, specifically the application of economic policies, is challenging. Although it may be easy to write an essay exploring hypotheticals, knowing the true impact of economic policies before they are placed is like trying to pin the tail on the donkey – you may nail it, but, more likely than not, you will miss with a degree of inaccuracy.

Immediately after the COVID-19 pandemic rocked the world, the U.K. economy slowed massively as lockdowns forced businesses to shutter their windows and average citizens were barred from going outside. Not long after this, the Russia-Ukraine war rocked the world once again. With Russia being one of the world’s largest exporters of oil, once many countries around the world sanctioned the nation (the United Kingdom included), energy prices skyrocketed in the United Kingdom (BBC, 2022).

In response to these issues, the British Broadcasting Company (BBC) published an article in May 2022 titled “Warning of Economic Downturn as Interest Rates Rise,” which foreshadowed a dire future for the U.K. economy by looking at rising levels of inflation and their impact on both the economy as a whole and the people affected (BBC, 2022). As a result of the COVID-19 pandemic and the Russia-Ukraine conflict, the article foreshadowed inflation to “hit 10% by the autumn,” and for Gross Domestic Product (GDP) “to contract by 0.25% in 2023” (BBC, 2022). Having first read this article just after it was published, I wondered what the current state of the United Kingdom is two years later and what the article correctly (or incorrectly) predicted.

Firstly, the inflation levels in the United Kingdom: As inflation began to climb in the United Kingdom in 2022, the Bank of England (Bank) increased interest rates from 0.75% to 1% to curb consumer spending and hopefully slow inflation (BBC, 2022). Using data provided by the Office of National Statistics (ONS), the Bank’s expectation of inflation to “hit 9% in the coming months … and to reach 10.25% by the end of the year” was somewhat correct; inflation peaked at 9.6% in October 2022, which validates the Bank’s short-term expectation, but, fortunately, inflation never hit 10.25% (ONS, 2023).

To combat this, the Bank continued to increase interest rates, reaching 3% in October and November 2022, and peaking at 5.25% in August 2023, where it remains today (Bank of England, 2023). Unfortunately, because of a response lag in the economy, by the time the Bank increased interest rates to 3%, inflation hit 9.6% but has since plummeted to 4% alongside the 5.25% interest rate (Bank of England, 2023).

From this, it is evident that, as the Bank increased interest rates, inflation in the United Kingdom fell, and, although the current inflation level of 3.4% (as of April 2024) is slightly above the Bank’s desired 2%, a 6.2% decrease in just under two years shows that the Bank’s monetary policies drastically helped combat the ballooning inflation levels (Bank of England, 2023).

One negative of implementing a contractionary monetary policy in the form of increasing interest rates is that it will lead to less consumption. Since the interest rate is essentially the cost to borrow from the bank, or the money you are paid for saving, less people will want to borrow and will instead choose to save their money. This means there will be less consumption in the economy in the long run, possibly causing GDP to shrink. In theory, contractionary monetary policy will cause inflation to fall, which is what the Bank desires, but it will also have negative opportunity costs. The best way to see these negative opportunity costs is to analyze the United Kingdom’s GDP.

The BBC article stated that the Bank’s policymakers expected the “UK economy to shrink rather than expand in the final three months of this year” (BBC, 2022). According to data from the ONS, the United Kingdom’s GDP growth fell to 0.1% in the second quarter of 2022 and has bounced between 0 ± 0.1% in the preceding quarters (ONS, 2023). Unfortunately, in the last two quarters of last year, the United Kingdom faced negative growth of -0.1% and -0.3%, respectively, placing the economy into a recession (ONS, 2023). The implications of these data points are worrying. In larger economies – like the United States – recessions are not always a cause for immediate concern. Anything ranging from changing consumer preferences to the amount the government spends can lead to a recession. However, in the case of the United Kingdom, a sustained pattern of recession and growth is cause for concern since it highlights a possibly unstable economy, disincentivizing foreign direct investment and trade, which can, in theory, lead to further economic issues in the long term (ONS, 2023).

Perhaps the United Kingdom is through the worst of its economic woes, or perhaps not, but only time will tell what the opportunity cost of the monetary policy the Bank implemented are and the long-term impact it will have on the U.K. economy. Everything has a price, and economics is no different. The Bank’s implementation of increasing interest rates to combat rampant inflation has its merits, but the possible repercussions are yet to be seen. As discussed previously, the increased interest rates may lead to less consumption in the economy, further damaging U.K. economic growth and further damaging the U.K. economy.

Edited by Baran Pasa

References

Inflation and the 2% target. (2024, April 17). Retrieved from Bank of England: https://www.bankofengland.co.uk/monetary-policy/inflation

Interest rates and Bank rate. (2024, February 1).  Retrieved from Bank of England: https://www.bankofengland.co.uk/monetary-policy/the-interest-rate-bank-rate

ONS. (2024, April 12). Monthly GDP and main sectors to four decimal places. Retrieved from Office for National Statistics: https://www.ons.gov.uk/economy/grossdomesticproductgdp/datasets/monthlygdpandmainsectorstofourdecimalplaces

ONS. (2024, April 16). Unemployment rate (aged 16 and over, seasonally adjusted: %. Retrieved from Office for National Statistics: https://www.ons.gov.uk/employmentandlabourmarket/peoplenotinwork/unemployment/timeseries/mgsx/lms

Thomas, D. (2022, May 5). Warning of economic downturn as interest rates rise. Retrieved from BBC: https://www.bbc.com/news/business-61319867

Treasury, H. (2022, May 19). Public spening statistics: May 2022. Retrieved from GOV.UK: https://www.gov.uk/government/statistics/public-spending-statistics-release-may-2022/public-spending-statistics-may-2022#total-expenditure-billions