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Recession likely to be ‘deeper’ but base rate peaks at four per cent – EY

by: Emma Lunn
  • 23/01/2023
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Recession likely to be ‘deeper’ but base rate peaks at four per cent – EY
The EY ITEM (Independent Treasury Economic Model) Club has warned that the UK is set for a deeper recession than previously thought, but it predicts the economy is still on course to grow again from the middle of 2023.

The EY economic forecasting group says it is now expecting a 0.7 per cent contraction in UK GDP this year – a downwards revision from the 0.3 per cent contraction expected in October’s Autumn Forecast.

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 per cent to 1.9 per cent. Growth of 2.2 per cent is expected in 2025, down from the previously forecast 2.3 per cent. The UK economy is expected to have grown 4.1 per cent in 2022.

Economists said there are significant risks, both positive and negative, to the forecast, particularly around energy and house prices, with a combination of high inflation, falling real incomes, rising interest rates, and tighter fiscal policy the primary drags on growth. 

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. 

A short, sharp shock

The EY ITEM Club added 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 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.”

Base to peak lower than expected

The EY ITEM Club expects inflation to average 7.2 per cent 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.

The group predicted that we have already passed the peak with inflation reaching 11.1 per cent last October. Inflation is forecast to fall to just under four per cent by the end of this year, partly reflecting recent falls in commodity and shipping prices and the reduction in the cost of wholesale gas.

The group also predicts that the Bank of England base rate will peak at four per cent in the spring.

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