UK outlook – Navigating troubled waters

Recession to give way to sluggish recovery

The UK economy has been flashing red for months and the recent decline in Q3 GDP, exacerbated by an additional Bank Holiday, likely marks the beginning of a recession driven by falling consumption, and declines in business and residential investment. We expect this to last around four quarters with a peak-to-trough decline of 1%. Following this, we expect inflation to retrace and alleviate real incomes pressures and for consumption to slowly recover. The slowdown is apparent in levels terms (Exhibit 8) with GDP remaining around its pre-pandemic level. We forecast growth of 4.3% in 2022, -0.7% in 2023 and 0.8% in 2024 (consensus 4.2%, -0.5% and 0.8%).

Labour demand now appears to have turned, lagging declines in economic activity. But a reduction in labour supply has seen unemployment remain low and kept the labour market tight. We see unemployment rising steadily over 2023 and 2024 to peak at 5% towards the end of 2024. We see unemployment averaging 3.6% in 2022, 4.5% in 2023 and 4.9% in 2024.

Energy effects to fade slowly as fiscal stance tightens

Inflation has risen sharply and now stands at 11.1%. We expect a slow decline in the headline rate, with upside contributions from food inflation likely to keep the headline above double digits into 2023. The Government’s decision to extend the energy price cap beyond March next year will help reduce inflation over 2023 as a whole. We forecast Consumer Price Index inflation to average 9.1% in 2022, 7.6% in 2023 and 2.8% in 2024 (consensus 9%, 6.3% and 2.5%).

The Government outlined plans for a sharp fiscal consolidation over the next six years, announcing measures totalling a net £62bn in tightening, despite the impact of energy price caps and recession. This reduces the deficit by £55bn through cuts in spending and increases in taxes. However, energy caps and other cost-of-living top-ups sees the fiscal stance loosen this year, compared to a planned tightening in March. It will now tighten less sharply next year, and the bulk of the tightening now takes place in 2024-2025 and beyond.

BoE first in, first out

The Bank of England (BoE) has increased interest rates by 300 basis points (bps) but the end appears in view. We expect it will increase rates by 50bps in December and February, and 25bps in March to 4.25%. The outlook thereafter, with a growing negative output gap and inflation expected to fall below target towards the end of the forecast horizon, should see the BoE consider loosening policy. We anticipate 25bp cuts in each quarter starting in Q4 2023 bringing rates to 3% by Q4 2024. The precise timing is likely to depend on the scale of labour market adjustment.

Counting down to 2024’s General Election

Negotiations between the European Union and UK on the Northern Ireland (NI) Protocol have resumed as the Government tries to avoid another election in NI. We think second NI Assembly elections by April are likely as the Government seems unlikely to resolve the deadlock. Local elections will also be held in May 2023 but a General Election should be held in 2024. Opinion polls currently suggest a Labour win. However, in contrast to recent elections, both main parties have been forced back to the political centre ground and economic orthodoxy, meaning the next election should be the least economically damaging for a decade.