It’s been a volatile week for the UK economy

Turning points in the economy can be a little confusing.

Two decades ago, then-Bank of England Deputy Governor Mervyn King said that John Travolta’s airing of Saturday Night Fever contained new economic statistics: „Old-fashioned disco dancing – sharp movements in unpredictable directions create more excitement with a good deal of noise.”

This is again a perfect description of the British economy.

This week should have taken a more credible stance on the path of inflation, and is a sign that three years of inflation crises and shocks are now washing out of the economy. The household energy shock that had pushed inflation above 11% reversed, bringing inflation below 7% in July.

But the statistics had a significant sting in the tail.

Measures of core inflation, such as core inflation, which strips out the direct impact of energy and food, were stuck at June’s rate. Services inflation actually rebounded to a 31-year high.

And it’s these measures of lingering inflation that experts focus more on in setting interest rates, but not the predictable drop in headline rates as the home energy cap gradually lowers gas and electric bills. And this came on top of some punchy hikes in wages (in cash terms).

So, this weekend, once again, financial markets furrowed their brows at UK government borrowing.

Ten-year gilt yields, a measure of the cost of decade-long loans to the government, rose to their highest levels since the 2008 financial crisis.

After similar market jitters in June, two-year yields rose again, supporting steady mortgage rates.

Markets are once again starting to assume that the UK and other similar countries are more inflation prone, and that higher interest rates will last longer. Indeed a further rate hike next month now looks very likely, and may follow.

Those disco-dancing figures are seen throughout the economy. On the high street, Wilco is in administration, while Marks & Spencer has reported better-than-expected profits.

At some supermarkets, such as H & Jodie’s Nisa Local in Walsall, owners tell me they plan to subsidize hot water bottles for customers who still can’t afford their energy bills.

Bar stands of chocolate, which cost £1.25 in the spring, are now £1.35, owner Harjit Singh shows me. Those moves and the fact that they haven’t returned to the £1 price point are perfectly consistent with the inflation rate falling to 7%.

Harjit revises all prices on weekly basis. On average, they are still increasing. Milk prices may be falling, but overall food price inflation will still be in double digits for the rest of the year, meaning a cost-of-living crisis is far from over.

In the central banking cliché, the Bank of England governor’s job is to empty the punch bowl before the party gets out of hand. But the economy as a whole is now neither boom nor party.

There seem to be pockets of froth that can justify higher interest rates. But interest rate hikes are a blunt instrument that affects a different segment of the economy — large mortgage lenders and indebted firms.

This can create a perception of unfairness, forcing higher rates on everyone else who experience frothy inflationary spending. Others might say that ultra-low interest rates have until recently subsidized massive borrowing at the expense of prudent savers.

What happens is that rates are raised to reduce economic demand and keep up with the decline in the economy’s supply capacity.

Fewer workers in certain sectors, higher trade barriers with Europe and a fall in investment could mean the UK produces less.

The country’s productivity has been hit by the pandemic, energy shock and post-Brexit policy choices.

The government has changed policies to try to get sick workers back into the labor force and eased trade barriers with some Asian markets, but these will take time to have an effect.

In fact, other efforts to improve the economy’s productivity may suffer as interest rates rise. Walsall-based BP Control & Automation has wired boxes that control everything from airport security, Formula 1 metal stamping to cow milking.

This is where the UK lags behind and where growth can be improved without fueling inflation. Boss Tony Hack tells me: „I think UK manufacturing generally manages inflation very well. It obviously has a big impact on the end user, the consumer, but I think from a manufacturing perspective… the cost of borrowing is very high. A concern.”

For now, medicine is more than disease here.

The housing market appears to be in a holding pattern. A rise in interest rates is managed by banks in the form of longer mortgage terms for borrowers. Withdrawals and dues are still surprisingly low.

There is some stress among mortgaged landlords, and prices have fallen from their peak, but currently Bank of England Governor Andrew Bailey wouldn’t call it a „correction”. As he told me earlier this month: „It’s an adjustment but I think we need to avoid… a crisis of preaching. It’s not.”

For now, the market reaction to every little twist in the data seems muted. The Bank of England noted that the UK appears particularly sensitive right now, particularly amid feelings of stagnant inflation. As it noted, there are some „very unusual” aspects of the UK economy right now.

Even if inflation is falling and real wages are starting to rise again, cuts in interest rates appear a bit off, and the path to normal economic conditions remains particularly bumpy.