A personal view from Ian Stewart, Deloitte’s Chief Economist in the UK.
For the first time in more than a year we are raising our forecast for UK growth. A recession is still on the cards, but a shorter, milder recession than had seemed likely. Better news on energy supply, inflation and the outlook for the economies of China, the US and the EU lie behind our upgrade.
We see the UK economy contracting by 0.8% this year, up from our previous forecast of a 1.4% decline in GDP. With Friday’s news that the UK GDP growth was flat in the fourth quarter of last year, following a contraction of 0.2% in the third quarter, the UK narrowly avoided a technical recession in the second half of 2022 (a recession is defined as two consecutive quarters of negative growth). That is unlikely to last and we see growth contracting for the first three quarters of this year.
The energy crisis has eased. Europe has sharply reduced its use of Russian gas and filled the gap with imports of liquified natural gas from the US and Qatar. Mild weather has helped reduce energy usage and gusty winds have lifted the power output from turbines to record levels. UK wholesale gas prices are running at about one-fifth of their summer peak and this is taking some of the pressure off consumers. The UK, and continental Europe, seems likely to avoid blackouts this summer.
UK inflation is running at 10.5% but has probably peaked and is likely to fall sharply over the next 18 months. Financial markets believe that the Bank of England has done the lion’s share of the monetary tightening that will be needed in this cycle. Markets are pricing in a peak in rates of around 4.5% compared with over 6.0% expected last September. The prospect of a lower peak in rates has led to a loosening of financial conditions, supporting risk assets, such as equities, and the outlook for growth.
While prospects for growth in the US and the euro area this year remain poor, lower energy prices and inflation have reduced the risks of deep downturns. Prospects for China, the world’s second-largest economy, have improved with the ending of the country’s zero-Covid policy. Sharp increases in the value of China’s currency and equities suggest that investors see stronger Chinese growth ahead.
Things look slightly better than they did at the start of this year, but they remain challenging. The Bank of England acknowledges that the risks to inflation are “skewed significantly to the upside”. Commodity prices are falling, but underlying inflation pressures remain strong.
To bring inflation back down without causing a recession requires not just lower commodity prices, but weaker wage growth and a softening of domestic price pressures. Previously that has been achieved through higher unemployment and shrinking demand pushing the economy into recession.
But could it be different this time, with central banks achieving a soft landing combining sharply lower inflation and continued growth? Falling commodity prices help, but to get inflation back to its 2.0% target will require wage pressures and home-grown inflation to ease. The resilience of the economy more than a year into a tightening cycle underscores the momentum of activity. A period of shrinking domestic demand and rising unemployment still looks necessary to curb domestically generated inflation. Milder, and shorter it may be, but a recession is still on the cards for the UK.
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