Explainer: As the new Prime Minister, Liz Truss inherits the UK economy, which is heading towards a recession

People walk across the Millennium Bridge with the City of London‘s financial district in the background, amid the coronavirus disease (COVID-19) pandemic in London, Britain January 20, 2021. REUTERS/Hannah McKay

LONDON, September 5 (Reuters) – Britain’s next Prime Minister Liz Truss will face an economy that is expected to slide into a long recession later this year, with inflation at a 40-year high and limited opportunity for growth to get going again.

Below is a summary of the main issues facing Truss, who won the keys to Downing Street on Monday by finishing first in the race for the Conservative Party leadership.

INFLATION

At 10.1% in July, the UK had the highest annual inflation rate among the advanced economies in the Group of Seven. Projections are for this to rise even further, with Goldman Sachs saying it could top 20% early next year if gas prices don’t fall.

Heavy reliance on imported gas and a rapidly weakening currency explain part of Britain’s inflation problem.

The pound has fallen about 8% against the dollar in the last three months alone – slightly underperforming the euro – making dollar-priced energy imports even more expensive.

TIGHT LABOR MARKET

The Bank of England is concerned about domestically generated inflationary pressures stemming from a tight labor market, where staff shortages in the wake of Brexit and the COVID-19 pandemic are driving wages, in some cases sharply.

Official data shows 49,000 fewer EU-born workers in the UK than in mid-2019, while the number of people classified as inactive due to long-term illness rose to a 19-year high of 2.39 million in June, up from about 300,000 since before that corresponds to pandemic.

However, there are some signs of a slowdown in labor demand. Job vacancies, which hit a record high of 1.299 million in the three months to May, began falling, while the number of jobless rose in June for the first time in 17 months.

TAX CUTS? SPENDING RULES?

Truss has pledged to cut taxes, beginning with a rollback of an increase in Social Security contributions and a suspension of so-called green taxes on utility bills. Economists have warned that a large injection of cash into consumers’ pockets could exacerbate Britain’s inflation problem.

Alongside the risk of fueling inflation, tax cuts or higher spending would further weigh on the UK budget deficit at a time when public debt is close to 100% of GDP.

NO BAILING OF THE BANK OF ENGLAND

Normally, a central bank forecasting a recession would cut interest rates, but the BoE has other concerns, most notably the risk that the inflation surge will create a wage-price spiral that could weigh on the economy for years. Markets expect the BoE to hike interest rates from the current 1.75% to 4.5% next year. Most economists see a lower peak.

The BoE also plans to start selling some of the bonds it has bought since the 2007-08 global financial crisis, in another form of monetary tightening.

CHANGE AHEAD FOR THE BOE

Truss said in July she wanted to provide “clear direction” for monetary policy and review the BoE’s mandate, raising concerns among investors about the central bank’s independence. One of their supporters questioned whether the BoE should retain its exclusive power to receive interest rates.

On Sunday, Truss said she was a “big supporter” of Bank of England independence.

writing by William Schomberg and Andy Bruce; Editing by Alexander Smith

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