Office for National Statistics (ONS) revisions have changed the narrative of the UK's pandemic experience, with a more significant downturn than previously thought. Q2 2022, however, was revised to show a modest rise in GDP, not a small fall, reducing the odds that the economy is already in recession. But the ONS now thinks output is still 0.2% below its pre-pandemic level.
Real household income fell for a fourth consecutive quarter in Q2, and there are likely to be further challenges to come for consumers as the impact of higher inflation continues to feed through. For many homeowners, this will be compounded by the impact of a significant rise in mortgage interest rates.
Much depends on how high rates go. The looser path for fiscal policy confirmed in the ‘mini-Budget’ is expected to boost household incomes, but will almost certainly mean interest rates rising to a higher level than previously expected.
In the EY ITEM Club’s view, current market expectations for the Bank of England Rate to reach almost 6% next year appear too high, and with inflation still likely to fall quickly next year, a peak of 4% is more likely. But this forecast depends on a decline in the risk-premium which investors are currently applying to the UK. That will require more detail on how last week’s fiscal plans are compatible with a sustainable fiscal position, and what the promised supply side reforms will look like – and how they will be delivered.
Martin Beck, chief economic advisor to the EY ITEM Club, says: “The Quarterly National Accounts for Q2 included substantial revisions to the recent path of GDP. We already knew that the ONS would judge that the fall in GDP in 2020 – the first year of the pandemic – was much larger (-11%) than previously thought (-9.3%), due to a more significant downturn in the services sector. The subsequent recovery is now seen as marginally stronger, with growth in 2021 now estimated to have been 7.5%, up from 7.4%.
“Q2 growth was revised from a small negative to a small positive, reducing concerns that the economy may already be in recession. But GDP is now estimated to be 0.2% short of pre-pandemic levels, not 0.6% above.
“Data on the consumer sector showed real household income falling 1.2% quarter-on-quarter in Q2, the fourth successive fall and comfortably the largest decline of that run. But some sizeable historical revisions meant that while the saving ratio fell to 7.6%, this was still just above the 7.2% averaged in the ten years before the pandemic. This suggests there is still scope for consumers to save less and spend more.
“But the situation for consumers remains challenging. The full effects of high inflation are still to feed through to household income, while the rise in swap rates since the mini-Budget could cause an increase in mortgage payments for borrowers on variable rates or coming off a fixed rate deal. This also heightens the risk of an abrupt correction in house prices, which could have significant implications for consumer spending.
“The outlook for the economy is uncertain. Sterling has recovered some ground lost last week and market interest rates have fallen back, aided by Bank of England intervention. The energy bill cap will substantially temper the prospective peak in inflation, bear down on expectations, and reduce the risk of a wage-price spiral.
“But as most of the proceeds of the personal tax cuts will go to better-off households, who are likely to save much of the gains, any boost to growth is likely to be small. And the looser path for fiscal policy means that interest rates are likely to rise to a higher level than previously expected. On economic grounds, the near-6% Bank Rate currently expected by investors by mid-2023 looks too high. Instead, the EY ITEM club expects Bank Rate to peak at 4%.
“However, this would still put considerable pressure on borrowers compared to the recent past. And crucially, the EY ITEM Club forecast depends on the successful articulation of how tax cuts will prove compatible with a sustainable fiscal position, and how the promised supply-side reforms will be delivered. On that score, a 23 November statement does seem quite far away.”