The Old Lady is in a sticky spot. Inflation is at a 40-year high and an early 1990s-style recession looms. The UK has a tight labour market, like the US, and an energy shock, like the eurozone. Finding an escape route may be further complicated by the unorthodox economic policies of Liz Truss, the candidate likely to become the next prime minister.
Tax cuts are set to be an important feature of the Truss premiership. That, as her rival Rishi Sunak argues, is likely to stoke inflation and put upward pressure on interest rates. Nigel Lawson, chancellor in the Thatcher government, draws parallels with the 1972 “dash for growth” Budget that was followed by years of high inflation.
In that era, gold outperformed. Its value increased almost seven-fold in real terms. Commodities like oil and wheat also did well. The dismal performance of equities showed they were a feeble hedge against inflation.
Analysis of markets dating back to 1900 tells a similar story. In periods of high inflation, equities’ real return was -10 per cent, according to a Credit Suisse study. Bonds meanwhile produced a negative return of 24.7 per cent. Separately, the study showed that in periods when interest rates were rising, investors in UK equities would have done better to stay in cash, which returned 0.6 per cent a year more.
Some sectors could do well, however. Though banks could be hit by bad loans as the recession bites, higher interest rates are fattening their net interest margins. Truss is an opponent of windfall taxes, making it unlikely she would copy the 1981 one-off bank levy imposed by her role model Margaret Thatcher.
Truss is avowedly pro-business. Her policy of cancelling corporation tax increases would benefit investors in companies that are doing well. But protecting company profits would be an unpopular policy when voters want help with utility bills. As the economy tips into recession, she may find it hard to stick to her policies. No plan survives contact with reality intact.
The Lex team is interested in hearing more from readers. Please tell us what you think the economic consequences of a Liz Truss premiership would be in the comments section below.