Bank of England Warns U.K. Faces Longest Recession in a Century

The U.K. can’t seem to catch a break. First, it lost its longest-reigning monarch this fall, and only a couple weeks later saw its shortest-serving prime minister resign.

Now, its central bank, the Bank of England, is warning the country is on the precipice of the longest recession in a century, as it pushed through the largest interest rate hike since 1989.

In announcing the 0.75% rate change to bring the current bank rate to 3%, the committee that sets monetary policy in the U.K. acknowledged they’re facing a “very challenging outlook.”

And in a news conference after the announcement, Andrew Bailey, the bank’s governor, said he realizes the tougher interest rate policy will be a pinch for Brits. But with inflation in the U.K. now at 10.1%, Bailey added: “If we do not act forcefully now it will be worse later on.”

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But with the close relationship between the U.S. and the U.K. — every U.S. state has jobs connected to an investment by a U.K. company and nearly 1.3 million Americans work for British companies in the U.S., according to the U.S. Department of State — where does that leave us?

Although no one likes to see their allies struggle, there are a few good reasons to believe the situation won’t be nearly as dire on this side of the pond.

The labor market is robust

In most recessions, economic output and employment decline simultaneously. Lower revenue compels businesses to cut back on staff, which leads to higher unemployment. Ultimately, higher unemployment leads to lower consumer spending and that creates a vicious cycle.

In 2022, however, unemployment is still at a record low. The official unemployment rate in October was 3.7% — a slight increase from the month before, but fairly close to the numbers seen pre-pandemic in February 2020. A robust job market is “historically unusual” during a recession, according to economists at Goldman Sachs.

This unusually strong job market could be deriving strength from another unusual source: corporate financial strength.

Companies are cash-rich

Corporations see a decline in sales and earnings during recessions. That process may have already started. However, U.S. corporations are sustaining profits and sitting on an immense cash hoard going into this recession.

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The average U.S. corporation’s after-tax profit margin is around 16% right now — the highest it’s been since 1950. In traditional recessions, this rate drops down to single digits. Meanwhile, these corporations are collectively sitting on over $3 trillion in cash. That’s a record level and also highly unusual for a recessionary environment.

Companies may have raised these funds during the era of easy money and low-interest rates over the past decade. Now, this cash is acting as a buffer and could allow companies to retain staff despite the economic slowdown.

The Fed’s hawkish stance

Another unusual factor of this recession is the Federal Reserve’s hawkish stance. In most recessions, the central bank cuts interest rates and adds more money to the economy to stabilize it.

In 2022, however, the Fed has been aggressively raising rates to curb inflation. Considering the strength of the job market and corporate balance sheets, the central bank may have more reason to keep raising rates.

What comes next?

“This is unsustainable,” says WSJ’s Jon Hilsenrath. He believes that one of two things must happen to resolve this misalignment: either the economy recovers swiftly, ending the recession, or the economy keeps dipping, compelling employers to cut jobs.

These two scenarios could potentially be the “soft landing” and “hard landing” the Fed has previously mentioned. Investors need to keep an eye on all indicators to see which scenario is playing out because the impact could be severe.

This could be an ideal time to bet on beaten-down growth and tech stocks if a soft landing occurs. However, in a hard landing, investors may need to take refuge in asset-backed defensive stocks like health care companies and real estate investment trusts.

In either case, 2022 and 2023 will no doubt be remembered as interesting years for investors.

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This article provides information only and should not be construed as advice. It is provided without warranty of any kind.