UK Inflation Data Give Sunak a Lifeline in the Buildup to Elections

Months from now, Prime Minister Rishi Sunak could look back on this week as the moment the UK political tide began to turn.

(Bloomberg) — Months from now, Prime Minister Rishi Sunak could look back on this week as the moment the UK political tide began to turn. 

One half of what Downing Street feared could be a devastating double punch was averted Wednesday when data showed a bigger-than-expected drop in inflation, putting Sunak back on course to meet a key pledge and potentially taking the UK out of recession territory later this year. That still leaves three special elections in England on Thursday to navigate, with the governing Conservatives braced for a drubbing.

Read More: UK Inflation Falls Below 8% for First Time in Over a Year

But soaring prices lie at the heart of Sunak’s travails. Inflation holds back growth as the Bank of England raises interest rates, adding billions of pounds to borrowing costs and also reducing the scope for tax cuts. It also feeds industrial action as workers strike in an attempt to recover real-terms cuts in their pay.

It also plays into a political pitch Sunak wants to build around economic competence for the general election expected in 2024. His pledge to halve inflation this year is part of that, and the prime minister got another boost Wednesday when Jaguar-owner Tata Group said it plans to build a £4 billion ($5.2 billion) battery plant to make batteries for electric vehicles.

According to Tim Pitt, a former Conservative adviser in the Treasury, lower inflation — especially if it helps the UK avoid a recession — could mean Sunak benefits from a very different economic backdrop early next year.

That would allow Sunak “to campaign on the basis that his plan to turn the economy around is working, and he deserves to be trusted to see it through,” Pitt, who is now a partner at Flint Global, said in an interview. “Today’s figures will come as a very welcome relief to the government.”

For months, the UK story has been one of a painful mortgage shock adding to spiraling costs of food and other basics as the UK heads for recession. The malaise has hurt Sunak politically, with a YouGov poll published Wednesday showing 65% of Britons were unhappy at the premier’s performance.

The opposition Labour Party has made hay during the crisis, surging to a double-digit lead in national opinion polls and using unfavorable comparisons between Britain and its international peers to brand soaring inflation “a hallmark for Tory economic failure.”

Wednesday’s data, though, suggested the economic tide may be turning. Inflation in June surprisingly dropped below 8% for the first time since March last year, and will likely fuel the “narrative that we are through the worst,” said Kitty Ussher, chief economist at the Institute of Directors.

Read More: Sunak’s Popularity Sinks to Lowest Since UK Premier Took Power

“What we saw with the inflation figures is that our plan is working,” Sunak told reporters in Gaydon, central England during a visit to Jaguar Land Rover’s headquarters. “Things are difficult for people right now but I’m determined to bring inflation down, today’s figures should give people some comfort that the plan is working. I’m going to stick to the course.”

Markets reacted immediately to the drop in inflation, which came after encouraging signs in last week’s jobs numbers, erasing much of the premium the UK was being charged to borrow. Traders who earlier this month were expecting rates to peak at 6.5% now forecast a peak of below 6% and for the rate hike cycle to be done by the end of the year. The BOE may even be cutting rates as Sunak heads into the election expected late next year.

“Inflation both halving and returning to the 2% target is vitally important for budgets and will ease some of this pressure we’re seeing, whether that’s on mortgage rates, cost of food, general cost of living,” Sunak’s official spokesman, Max Blain, told reporters Thursday. 

The swaps curve on which fixed-rate mortgages are priced dropped by about 0.65 percentage points for both two-year and five-year deals. For borrowers that will feel like a half-point cut in rates once lower costs are passed on. That may help neutralize Labour’s attack line about the “Tory mortgage time bomb.” For the government, it will mean a near £10 billion saving in the cost of servicing its debt.

Food prices, which have been growing at around 1.5% a month since April last year, increased by just 0.3% between May and June – the slowest rate in 15 months. Inflation is now back on the BOE’s forecast trajectory, and, if it maintains the course, will drop to 6.9% in July.

That raises the prospect of an increase in real pay before the autumn for the first time since October 2021, placating striking public sector workers.

Meanwhile Tata’s battery plant announcement could offer an immediate political lift to Sunak. It comes in the same week his illegal migration bill aimed at stopping asylum seekers arriving by boat — one of his five key pledges — finally cleared Parliament after months of wrangling.

Neither Tata nor the government have said where the battery plant will be, but people familiar with the matter told Bloomberg the site is in Somerset, southwest England, not far from where the Tories are seeking to hold its Somerset and Frome seat in one of the special elections Thursday.

Read More: Don’t Say Tory: How Sunak’s Party Aims to Survive Key Votes

The Tories are defending huge majority in Somerton, and in Selby and Ainsty in northern England, and shouldn’t ordinarily fear losing them. Another vote is in Boris Johnson’s former seat of Uxbridge and South Ruislip in northwest London.

But they’ve been downplaying expectations, and bookmakers’ odds suggest they will lose all three. Keir Starmer’s Labour are predicted to take Selby and Uxbridge, while the Liberal Democrats have targeted Somerton in an effort to capitalize on the Tories’ unpopularity.

Those low expectations mean that if they hold just one of the seats, the Tories are likely to try to spin it as a positive result that builds on the inflation boost. While the rate is still high at 7.9%, the outlook for rates is back to much where it was at the end of May, when forecasts for a recession had receded and Sunak was on track to meet his goal of halving inflation by the end of the year.

Still, the UK remains an outlier on inflation, which is above every other Group of Seven advanced economy. The next worst is Italy at 6.7%. In the US, it’s 3%, and 2.8% in Canada. The question is whether that reflects a structural problem or if the UK is taking longer to follow in others’ wake, partly because of the regulatory arrangement for household energy bills that delays the impact of falling wholesale gas prices for three months.

Read More: Sunak Officials Play Down Talk of Cooling Prices Before Key Week

The latest data, albeit a single month that could reverse, strengthened the government’s argument that the issue is one of timing. 

“We are on the same path on many European economies just a few months behind,” John Glen, chief secretary to the Treasury, told Bloomberg TV. “Today’s numbers are encouraging but we must keep going. People are hurting – but we are on the right trajectory.” 

Election results in the early hours of Friday could yet dampen Sunak’s mood. And it may already be too late for the prime minister as he tries to persuade voters that after 13 years of turmoil, his Tories deserve another chance.

But his key week —  so far — could hardly be going better.

–With assistance from David Goodman and Jamie Nimmo.

(Updates with Sunak spokesman quote in 11th paragraph.)

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