2023 looks set to be an exceptionally tough year for the UK economy. The country is almost certainly already in a year-long recession that will likely prove to be deeper than it was in the early 1990s.
Pressures on real household incomes will intensify as rising interest rates follow rising inflation.
Admittedly, the government’s austerity measures will not hurt growth in the short term, according to Thomas Pugh, economist at RSM UK.
“Most of the pain has been delayed until after the next general election. But they won’t help the economy much in the short term either,” Pugh said.
Not all recessions are the same
However, not all recessions are created equal. Pugh expects a peak-to-valley decline in GDP of about 2.5 percent.
“That would be slightly less than the recession of the early 1990s and significantly less than the global financial crisis,” he stressed.
Pugh also expects the unemployment rate to rise from the current 3.6 percent to about 5 percent by the end of 2023, causing about 200,000 job losses.
“Hospitality and retail are likely to suffer the biggest losses as consumer spending power shrinks.”
Thomas Pugh
Looking for the good news? Inflation will fall throughout 2023.
The bad news is that it is expected to average around 7.5 percent for all of next year.
High inflation and a tight labor market will force the Bank of England (BoE) to raise interest rates from the current 3 percent to around 4.5 percent early next year, Pugh said, adding that “it will take 2024 for the Bank considering a rate cut”.
Continued pressure on real incomes
Households’ disposable income has been hit by the cost-of-living crisis, which has seen inflation rise from 0.5 percent in early 2021 to 10.1 percent in September 2022 due to soaring food and energy prices.
The government’s Energy Price Guarantee (EPG) has protected homes and businesses from the worst of the energy crisis, Pugh said.
The story goes on
But he added that utility prices will rise by a further 20 per cent in April 2023 when the Government’s energy price guarantee for the average annual electricity bill rises from £2,500 to £3,000.
“As if that weren’t enough, the rise in mortgage rates will continue to squeeze household disposable income,” Pugh continued.
Mortgage rates have risen well above the base rate as banks anticipate higher interest rates, meaning anyone unlucky enough to get a mortgage over the next few months will have to dedicate a proportion of their income to rising mortgage rates.
Pugh highlighted that the average borrower who rolls over a two-year fixed-rate mortgage today at a 75 percent LTV ratio for another two years will see the portion of their income absorbed by monthly repayments drop from 22 percent to about 34 percent percent will increase.
“Furthermore, a loosening of the labor market, as companies reduce hiring and even start shedding workforces, will cause nominal wage growth to fall back to more ‘normal’ levels,” he said.
“Add higher taxes, potentially 1 percent of GDP, and a real cut in public sector wages, and the outlook for 2023 is bleak for household real disposable income,” Pugh added. All in all, he expects RHDI to contract by 2.5 percent in 2023. That would be the largest drop on record.
However, on average, consumers have significant savings of around 10 percent of GDP.
“But with consumer confidence at a record low, we don’t expect them to benefit much from these savings,” Pugh noted.
“The latest data suggests consumers are adding to their savings stack rather than diving into it.”
Thomas Pugh
So consumers have less money to spend and are less willing to spend it. This will inevitably result in a significant reduction in consumer spending, particularly in consumer staples such as hospitality and retail goods.
“We expect total consumer spending to fall by 2 percent next year,” Pugh said.
Rising interest rates and falling demand will also reduce business investment, which is still about 8 percent below previous levels, he continued.
“This is mainly due to a slump in investment in offices and transportation as demand for office space and travel has not fully recovered as many people continue to work remotely.”
Inflation is slowing but still elevated
The recession will help ease domestic inflationary pressures. A number of leading indicators are already pointing to easing domestic price pressure.
With energy price inflation on the verge of a crucial drop, UK CPI inflation will soon start falling from a 41-year high of 11.1 percent in October, Pugh said.
In addition, Brent crude’s current level of $80 suggests that the contribution of motor fuels to the conduction rate will fall to almost zero by March.
“The stabilization of food prices over the past six months also suggests that food CPI inflation will fall rapidly next year,” he noted.
Meanwhile, the collapse in shipping costs and the increase in retailers’ inventories suggest that core goods prices will fall back soon.
“Nevertheless, inflation will remain high for most of next year. We expect inflation to be around 7% in mid-2023 and around 4% by the end of 2023, but could fall below the BoE’s 2% target in the second half of 2024.”
However, there is a risk that inflation will prove more stubborn than we think, either because a tight labor market means wage growth will slow more slowly than we expect, or because companies are rebuilding margins.
In fact, the Q4 edition of the RSM UK MMBI showed that mid-market companies are getting better and better at passing on costs.
“However, the recession and weaker demand will make it difficult for midsize companies to continue passing on higher costs,” Pugh said.
With inflation set to remain high throughout 2023, companies will struggle to continue to defend their margins.
The labor market will loosen up, but not by much
The recession will inevitably lead to a rise in unemployment.
Falling demand is reducing the need for staff, but this is combined with the huge pressure on companies’ costs and rising interest rates, forcing companies to lay off staff.
“However, we do not expect unemployment to rise, particularly in sectors with skill shortages,” Pugh said.
“The labor market is incredibly tight because of a labor shortage, not an over-demand for labor.”
Thomas Pugh
And given the recent challenges companies have had in hiring and the relatively short recession, companies will have a greater incentive to hoard labor than in previous periods of economic weakness, he continued.
The extraordinarily tight job market probably explains why this quarter MMBI reported 41 percent of firms they hired more despite the gloomy economic outlook in the fourth quarter.
“Ultimately, we expect the number of job vacancies to fall from a record low to below one million and for the unemployment rate to peak at 5 percent by the end of next year, well below the peak of 8.5 percent reached in the period that followed global financial crisis,” Pugh said.
If all of this was due to white-collar workers becoming unemployed, it would mean about 400,000 job losses.
“But we expect some people who are currently inactive and currently not looking for work to return to the labor market to increase their income,” he said.
This is likely to increase the labor force participation rate and means the total loss of jobs could be closer to 200,000.
By CityAM
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