Following a forecast 0.3% decline in GDP in Q3, the UK economy is expected to contract around 0.2% each quarter from Q4 this year through to Q2 2023, resulting in GDP falling 0.3% in 2023 as a whole. This is a significant revision from the 1% growth forecast for 2023 in the EY ITEM Club’s July Summer Forecast – although the scale of the upcoming downturn is expected to be shallow relative to previous recessions thanks, in part, to the Government’s intervention on household and business energy bills.
As the squeeze on real incomes from high inflation eases, tax cuts take effect, the cheap pound boosts net exports and the tightening cycle for interest rates ends, GDP should return to growth in the second half of 2023. The economy is then expected to expand 2.4% in 2024 (unchanged from the Summer Forecast) and 2.3% in 2025.
Meanwhile, the EY ITEM Club’s growth forecast for 2022 has been upgraded to 4.3% (from 3.7%) after historical data revisions by the Office for National Statistics.
Hywel Ball, EY UK Chair, says: “There’s no doubt the UK economy faces a difficult period ahead, with global headwinds adding to domestic pressures. The silver lining is that the Government’s intervention on energy bills is expected to limit the extent of the downturn, while ONS data suggests that households have access to a larger cushion of pandemic savings than previously thought.
“Nevertheless, there are very significant risks to the forecast, with the potential for further surprises or global instability creating additional drags on growth. Businesses will need to think very carefully about their resilience and plan for different scenarios, while also being mindful of the support they provide to their customers and employees.”
Inflation is at a 40-year high, but interest rates will peak lower than market expectations
The EY ITEM Club now expects inflation to peak at just below 11% in October, with the Government’s intervention on energy bills heading off what could have been peak inflation of around 15%. Average annual inflation is still expected to outpace annual average wage increases until 2024, with household real incomes likely to decline over the next 12 months to the greatest extent since the 1970s.
Inflation is expected to average 8.9% in 2022, 5.5% in 2023 and fall below the Bank of England’s 2% target (to 1.8%) in 2024.
While high inflation means significant increases in the Bank of England’s base rate are likely, the EY ITEM Club forecasts a peak of 4% next spring rather than the 5.5% high currently expected by the markets. Rate cuts are then forecast for the end of 2023 and in 2024.
Martin Beck, the Chief Economic Advisor to the EY ITEM Club, says: “While inflation is still high, forces are emerging which should bear down on price rises, whether from the energy price cap, rapidly falling shipping costs and commodity prices and weaker demand at home and abroad. Pushing in the other direction is the weaker pound, while the mini-Budget’s tax cuts are expected to nudge inflation higher in the medium-term. However, these latter factors aren’t expected to stop inflation falling below the Bank of England’s target in the next two years.
“As the Bank’s Monetary Policy Committee considers the future path for interest rates, it will need to be mindful of the financial stability risks of raising rates too far, too fast. This is one factor that should keep the Bank Rate peaking beneath current market expectations. “Crucially, however, this forecast depends on investors attaching fewer risks to the UK economy than they are at present, and on the Government setting out a clear medium-term fiscal strategy.”