The UK economy faces an exceptionally difficult 2023 | Daily News Byte

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2023 is expected to be an exceptionally difficult year for the UK economy. The country is almost certainly already in a year-long recession, which will probably prove deeper than the recession experienced in the early 1990s.

Rising interest rates coupled with rising inflation will intensify the pressure on real household incomes.

Admittedly, the government’s austerity measures will not hurt growth in the short term, according to RSM UK economist Thomas Pugh.

“Most of the pain is delayed until the next general election. But they won’t help the economy much in the short term,” Pugh said.

Not all recessions are created equal

However, not all recessions are created equal. Pugh expects a peak-to-trough decline in GDP of about 2.5 percent.

“It will be slightly shorter than the recession of the early 1990s and significantly shorter than the global financial crisis,” he stressed.

Pugh also expects the unemployment rate to rise from 3.6 percent now to about 5 percent by the end of 2023, with about 200,000 job losses.

“Hospitality and retail sectors are likely to suffer the most as consumers’ discretionary spending power shrinks.”

Thomas Pugh

Looking for good news? Inflation will decrease in 2023.

The bad news is that it will likely stay around 7.5 percent over the next year.

High inflation and a tight labor market will push the Bank of England (BoE) to raise interest rates to 4.5 percent from the current 3 percent early next year, Pugh said, adding that “it will be 2024 before the Bank considers cutting rates.”

A steady decline in real income

Household disposable incomes have been hit by the cost-of-living crisis, with inflation rising from 0.5 percent in early 2021 to 10.1 percent in September 2022, driven by sharp increases in food and energy prices.

The government’s Energy Price Guarantee (EPG) has protected households and businesses from the worst of the energy crisis, Pugh pointed out.

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 an average annual utility bill rises from £2,500 to £3,000.

“As if that weren’t enough, rising mortgage rates will further sap households’ disposable income,” Pugh continued.

Mortgage rates have risen above the base rate as banks anticipate higher interest rates, meaning anyone unlucky enough to have a mortgage will see a share of their income spent on mortgage interest over the next few months.

Pugh said the average borrower rolling on a 75 percent LTV ratio two-year fixed-rate mortgage today for another two years would see their income ratio increase from 22 percent to about 34 percent through monthly payments.

“What’s more, a slackening labor market, as companies cut back on hiring and even begin downsizing, will result in nominal wage growth returning to more ‘normal’ levels,” he said.

“Add in higher taxes and a real-terms cut in public sector salaries of a potential value of 1 percent of GDP, and the 2023 projection is bleak for real household disposable income,” Pugh added. In all, it expects the RHDI to contract by 2.5 percent in 2023. That would be the biggest drop on record.

Admittedly, consumers have, on average, significant levels of savings, amounting to about 10 percent of GDP.

“But given that consumer confidence is at record lows, we don’t expect them to cut back on these savings much,” Pugh noted.

“The latest data suggests that consumers are adding to their savings pile rather than dipping into it.”

Thomas Pugh

Therefore, consumers have less money to spend and are less willing to spend. This will inevitably mean a sharp drop in consumer spending, particularly on discretionary items such as hospitality and retail goods.

“We expect a 2 percent decline in total consumer spending next year,” Pugh said.

Rising interest rates and falling demand will also dampen business investment, which is still about 8 percent below its previous level, he continued.

“This is mainly driven by a slowdown in investment in offices and transport equipment, as demand for office space and travel has not fully recovered as many people continue to work remotely.”

Inflation is slowing but still rising

A slowdown would go some way to reducing domestic inflationary pressures. Some leading indicators are already pointing to an easing in domestic price pressures.

UK CPI inflation will soon start to fall from October’s 41-year high of 11.1 per cent, with energy price inflation coming down decisively, Pugh said.

In addition, the current level of Brent crude oil prices at $80 indicates that the contribution of motor fuel to the headline rate will be almost zero by March.

“The stability in food prices over the past six months points to a sharp decline in food CPI inflation next year,” he noted.

Meanwhile, a drop in shipping costs and an increase in retailers’ stock levels suggest that prices of staple goods will soon bounce back.

“However, inflation will remain high for most of next year. We think inflation will remain around 7 percent in mid-2023, around 4 percent by the end of 2023, but could fall below the BoE’s 2 percent target in the second half of 2024.”

However, there is a risk that inflation proves stickier than we think, because a tight labor market means wage growth slows more than we expect or because companies are rebuilding margins.

Indeed, the Q4 edition of the RSM UK MMBI shows that middle market companies are getting better at passing costs.

“That said, the recession and weak demand will make it more difficult for middle-market companies to continue to pass on higher costs,” Pugh said.

With inflation remaining high through 2023, it will be difficult for companies to continue to defend their margins.

The labor market will loosen, but not by much

A recession will inevitably lead to an increase in unemployment.

A fall in demand reduces the need for staff, but this is coupled with a drastic reduction in firm spending and rising interest rates, forcing firms to cut staff.

“However, we do not expect unemployment to increase particularly in sectors experiencing skills shortages,” Pugh said.

“The labor market is incredibly tight because of a lack of supply of labor, not because of an excess demand for workers.”

Thomas Pugh

And given recent challenges in hiring and a relatively short recession, firms will have more incentive to hoard labor than in previous periods of economic weakness, he continued.

The exceptionally tight labor market may explain why, according to the MMBI this quarter, 41 percent of companies said they hired more staff in Q4, despite a grim economic outlook.

“Ultimately, we expect vacancy levels to fall from near-record levels below one million and the unemployment rate to peak at 5 percent by the end of next year, significantly lower than the peak of 8.5 percent later. global financial crisis,” Pugh said.

If all of that came from the unemployment of employed workers, that would mean a loss of about 400,000 jobs.

“But we expect that some people who are currently inactive, who are not currently looking for work, will want to increase their income as they get back into the workforce,” he said.

This would likely increase the labor market participation rate and mean total job losses could be closer to 200,000.

By CityAM

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