Press release

23 Jan 2023 London, GB

Recession likely to be deeper – but not longer – than previously expected, says the EY ITEM Club Winter Forecast

The EY ITEM Club has downgraded UK GDP growth projections for the next three years, with warnings that a recession is likely to prove deeper than previously expected. A combination of high inflation, falling real incomes, rising interest rates, and tighter fiscal policy are the primary drags on growth.

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  • New EY ITEM Club forecast warns the UK is set for a deeper recession than previously thought, but the economy is still on course to grow again from the middle of 2023.
  • 0.7% contraction in UK GDP now expected for this year – a downwards revision from the 0.3% contraction expected in October’s Autumn Forecast.
  • 2023 would be the first calendar-year economic decline for the UK since 2009.
  • The EY ITEM Club says there are significant risks, both positive and negative, to the forecast, particularly around energy and house prices.

LONDON, MONDAY 23 January 2023 – The EY ITEM Club has downgraded UK GDP growth projections for the next three years, with warnings that a recession is likely to prove deeper than previously expected. A combination of high inflation, falling real incomes, rising interest rates, and tighter fiscal policy are the primary drags on growth. 

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The EY ITEM Club’s Winter Forecast says that the UK economy is now expected to contract 0.7% in 2023, bigger than the 0.3% contraction predicted in October. The impact of tighter fiscal policy and a deeper downturn, particularly on business investment, means the growth forecast for 2024 has also been downgraded from 2.4% to 1.9%. Growth of 2.2% is expected in 2025, down from the previously forecast 2.3%. The UK economy is expected to have grown 4.1% in 2022.

Key factors behind the downgrade for the 2023 forecast include the reduction in the generosity of the Energy Price Guarantee, additional taxes on high-earners and unearned income coming into effect from the spring, and signs that the housing market is slowing faster than many had anticipated.

GDP growth in November 2022 means it’s now more touch-and-go whether a recession began last year. However, the challenging outlook suggests that GDP is likely to shrink over the first half of 2023. That said, the UK economy is still expected to return to growth in summer 2023 and into 2024 as inflation falls back and consumers use strong balance sheets to save less and spend more. The EY ITEM Club adds that this downturn should prove less damaging for the economy – and shorter – than downturns in the 1980s, 1990s, and 2000s. This is due to the unusual and externally driven nature of the recession, combined with the prospect of inflation falling back quickly this year. Nevertheless, the economy is not expected to regain its pre-pandemic size until the middle of 2024.

Hywel Ball, EY’s UK Chair, says: “The UK’s economic outlook has become gloomier than forecast in the autumn, and the UK may already be in what has been one of the mostly widely anticipated recessions in living memory.

“The one silver lining is that, despite being a deeper recession than previously forecast, it won’t necessarily be a longer one. The economy is still expected to return to growth during the second half of 2023 and has been spared any significant new external shocks in the last three months from energy prices, COVID-19 or geopolitics. Meanwhile, the chief headwind to activity over the last year – high and rising inflation – may be starting to retreat, while energy prices are falling too.”

Inflation should fall significantly this year

The EY ITEM Club expects inflation to average 7.2% this year. The £500 increase in the energy price guarantee and a likely increase in the weight attached to energy in the consumer spending basket the ONS uses to measure consumer prices are expected to add around 0.7ppts to inflation in April.

However, while inflation in 2023 will be high by historical standards, it is likely that we’ve already passed the peak with inflation reaching 11.1% last October. Inflation is forecast to fall to just under 4% by the end of this year, partly reflecting recent falls in commodity and shipping prices and the reduction in the cost of wholesale gas.

On a calendar year basis, average earnings are forecast to trail average inflation until next year, when earnings are predicted to grow 2.6% and inflation is expected to average 2.3%. Average earnings are expected to grow at half the average inflation rate this year, at just 3.6%.

As the inflation outlook becomes less concerning, the EY ITEM Club thinks it is likely that the Monetary Policy Committee will press pause on its rate hiking cycle soon, with Bank Rate expected to peak at 4% in the spring.

A modest rise in unemployment means the housing market should avoid a serious correction

Positively, the EY ITEM Club expects the recession to have a relatively limited impact on unemployment when compared to previous downturns. A tight jobs market and evidence of worker shortages in some sectors suggests some employers may opt to hold onto workers and reduce vacancies instead. Unemployment is forecast to peak just below 5% this year.

The relatively modest rise in unemployment should help in limiting the forecast fall in house prices. The EY ITEM Club expects house prices to fall by 2.4% this year, with another fall of around 3% in 2024, thanks to the impact of significantly higher mortgage rates and the wider economic downturn.

Martin Beck, chief economic advisor to the EY ITEM Club, says: “We’re forecasting a relatively modest rise in job losses by the standards of past recessions, which should help limit some of the knock-on effects of the downturn. Importantly, the combination of more people holding onto their jobs and greater forbearance by lenders, such as switching mortgage holders to interest-only deals, should reduce the risk of forced home sales. Overall, we think that average property prices will fall by around 10%, from peak to trough, over the next 12-18 months.”

A fall in consumer spending

Elsewhere, the Winter Forecast says that consumer spending is likely to fall 1.4% this year, with growth of 2.3% expected in 2024. This is a revision from the EY ITEM Club’s Autumn Forecast, which predicted a 0.7% contraction for 2023 and growth of 2.9% in 2024.

Martin Beck says: “In theory, households drawing on the savings accumulated during the pandemic period could help mitigate the impact on consumer spending from high inflation, real wage reduction, and job losses. However, the latest data signals some reluctance among consumers to do so, suggesting that, for now, consumers are more concerned about their own financial prospects. But as the economic outlook brightens later this year, we think consumers will show a greater appetite to save less and borrow more.

“The housing market is a significant risk in this forecast and a larger, more abrupt price correction than predicted would have significant ramifications for the wider economy. Other key risks to the forecast include the prospect of further instability in the energy market and inflation proving more stubborn, or falling faster, than expected.”

Business investment will likely remain a relative weak spot

After business investment grew a projected 5.2% in 2022 – leaving it 7% below pre-pandemic levels – the EY ITEM Club now expects a fall of 0.8% this year. Weaker business investment is one of the factors likely to slow the recovery from recession. Business investment growth of 3.7% is forecast for 2024.

The EY ITEM Club report says it’s likely that investment growth in 2022 received a boost from the temporary ‘super-deduction’ tax incentive, with some investment brought forward to benefit from the tax break. However, this is expected to be countered by some payback following the super-deduction’s end in April, which the EY ITEM Club says was probably only partially offset by the temporary £1m level of the Annual Investment Allowance becoming permanent.

Beyond tax effects, the EY ITEM Club says the environment for business investment is poor. Recessions typically see business investment fall by more than GDP as businesses faced with weak demand often tend to delay or cancel projects.

Hywel Ball comments: “Businesses are facing an unprecedented ‘trilemma’ of supply chain pressures, rising inflation and high energy prices creating challenging trading conditions and making it increasingly difficult to balance competing priorities. When faced with this environment, it’s crucial that business leaders capitalise on the opportunities and manage their risks effectively through scenario planning and stress testing. Higher energy prices could, for example, be an opportunity for more investment in energy efficiency or green energy, while a weaker pound could encourage exporters to take advantage of their more competitive international position.”