UK Economy: Growth, Inflation and Productivity

Lord Lamont of Lerwick Excerpts

Thursday 29th June 2023 Lords Chamber

[Lord Lamont of Lerwick (Con)]

My Lords, I thank the noble Lord, Lord Eatwell, for initiating this debate. It is always very interesting to listen to him; he always makes very thoughtful contributions.

I hope he will forgive me if I do not follow him on the long-term issues he outlined. This is because I want to concentrate on one part of what he talked about: inflation. The immediate problem this country faces is extremely serious. This is not because I want to ignore growth, but because I believe we cannot have sustained growth without first getting on top of inflation. Stability, sound finance and low inflation are preconditions of growth.

It is possible to be too downbeat about the UK’s economic growth. In 2020 and 2021, the UK had the highest economic growth of any G7 country. The eurozone is in recession, as is Germany. It is true that the UK has not recovered to its pre-Covid level, unlike several major European countries, but these are tiny differences in very small numbers. Some people talk about economic growth as though they are the first people ever to have thought of the idea—“With one bound, Jack will be free”. Of course, growth must be the ultimate objective of economic policy, but it cannot just be conjured into existence by politicians snapping their fingers.

Sadly, I do not believe that we can return from the present situation to inflation at 2% without a contraction—not a recession, but some contraction in activity—to realign demand with weaker supply. Of course, we have also to do what we can to increase supply. We need to bear in mind that, in this situation, the UK has a very tight labour market, with unemployment at 3.8%, 1 million vacancies and rising wages. We have a level of wage demands and wage increases that is incompatible with the 2% target set by the Bank of England.

Largely as a result of Covid and Ukraine, we have taxes that are far too high—and borrowing, for the same reasons, is also far too high and leaves little fiscal room for manoeuvre. Some suggest that the alternative to present policy is to seek a return to higher real incomes through economic growth and targeted tax cuts—again, with one bound Jack would be free. The hope that tax cuts and growth, if it materialised, would moderate demands for higher pay in the tight British labour market seems to me plainly illusory. If such an approach could ever have been on the cards, it plainly now cannot be after last year’s mini-Budget. Challenging the current approach risks upsetting market confidence.

As the noble Lord, Lord Eatwell, said, the latest inflation figures were extremely disappointing and, not to put a fine word on it, bad. Not only did inflation stop falling but core inflation actually increased, as did services inflation and the increase in wages. The UK is now an outlier in inflation, as the noble Lord said. We have a domestically generated element in our inflation. The Bank of England has responded by putting up rates by half a percentage point, and mortgage rates had anticipated that development and already risen in line with the market.

The changes in the mortgage market to more fixed-rate mortgages means that the impact of interest rate changes takes much longer today. The Resolution Foundation calculates that two-thirds of the impact of rising rates since 2021 still has to come through. Some 1.3 million people have fixed-rate mortgages expiring in the 12 months from 1 July. These figures have led to talk of a mortgage catastrophe impacting on the economy but, with a little flexibility and help from the banks, it need not be so. So far, mortgage holders have been remarkably resilient. This generation of mortgages were lent out far more cautiously than in previous cycles; the mortgage affordability tests imposed by the Bank of England mean that many borrowers already have a decent margin to cope with shocks.

Some voices have called for a government mortgage rescue package, but it makes no sense for the Bank of England to bear down on inflation by raising interest rates if, at the same time, the Government are to subsidise rising interest rates. Nor is it equitable to ask those not owning houses to subsidise those already on the ladder. Many renters pay a higher percentage of their income on rent than home owners do on mortgage payments. Regaining control is urgent, the best way to support home owners and essential for getting back growth.

Obviously, I support the independence of the Bank of England, and I supported it when Gordon Brown made that move, but the credibility of the Bank of England is on the line today. In the recent past, it has not sounded or acted as though it was determined to defeat inflation. In the summer of 2021, the Bank refused to halt the quantitative easing programme unleashed during Covid, even when it became inappropriate as prices accelerated and distortions in asset prices were obvious. In November that year, with inflation three times its target, the Bank was content to leave the base rate at 0.1%. If the Bank is to regain the confidence of investors, it needs to focus hard on this one core objective.

In recent years we have been through an extraordinary series of exceptional events. It is hardly surprising that growth, not just in this country but in many countries, has been slower than in the past. Some want to peddle illusory easy answers but, as the Prime Minister said, people know that if something is too good to be true, it is not true. Difficult as it is, I believe that the Government are on the right track, and I urge them not to be diverted.