US warns of risks to Britain's economy if monetary policy tightens

US economists are warning that the UK economy faces a sharp recession and a flood of job losses if interest rates hit the 6 per cent level financial markets believe is on the cards.

Household budgets are under increasing strain again as mortgage costs spike, while rocketing corporate insolvencies suggest firms, particularly the smaller ones that account for the bulk of employment, are struggling to cope with higher borrowing costs, Bloomberg reports.

Markets expect another quarter point hike next week to 4.75 per cent and for rates to reach 5.75 per cent, or possibly even 6 per cent, next year. That would be a 22 year high and add £250 ($321) a month to the average mortgage payment, according to the Resolution Foundation – five times more than the saving from the recent drop in energy prices.

Neal Hudson, a property market analyst at BuiltPlace, has calculated that homeowners would be spending almost a quarter of their income on mortgage costs, up from 17 per cent in 2020, with rates at 6 per cent. For those who have to remortgage at the higher rates, or who are on tracker deals, the cost of living crisis will feel more severe than during the energy price shock.

“If the Bank does push rates up as much as markets expect there will be a recession,” said Gerard Lyons, chief economist at wealth manager Netwealth. Erik Britton, chief executive of Fathom Consulting, agreed: “A recession is in the post if rates hit 6 per cent.”

Mortgage borrowers already are hurting from the 12 rate rises the BOE has delivered since 2021, putting the benchmark lending rate at its highest since 2008. That along with jitters in financial markets has driven up the cost of both mortgages and business loans, with both Britton and Rob Wood, chief UK economist at Bank of America Merrill Lynch, saying the corporate sector is near a tipping point.

They fear that a spike in insolvencies will drive up unemployment and trigger a second wave of layoffs as companies that are currently hoarding labor due to worker shortages let people go. Consumer spending would collapse at that point, and a downturn would be inevitable. House prices would crash as people who could no longer meet their mortgage payments turn forced sellers.

Megan Greene, who joins the BOE’s rate-setting committee next month, told Parliament this week that an “abrupt” end to “labor market hoarding … would have significant implications for consumer confidence and for consumption and could prompt a recession”.

As companies released staff they were hanging on to, unemployment would suddenly spike, said Raghuram Rajan, a former International monetary fund chief economist and professor of finance at University of Chicago Booth School of Business.

“Then you have more unemployment than you want, because these things move in a non-linear fashion. Unemployment is terrible for demand and terrible for housing because unemployed workers who can’t make their mortgage payments will sell.”

It’s a gloomy scenario that Britain may well avoid. Most economists think rates will peak below the levels markets have priced in. The current worries among investors were triggered after a jobs market report showed inflationary pressures remained much stronger than expected, and figures due in the next few weeks could well surprise to the downside.