Shorter, milder UK recession in prospect

13 February 2023

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.

For the latest charts and data on health and economics, visit our Economics Monitor:
https://www2.deloitte.com/uk/en/pages/finance/articles/covid-19-economics-monitor.html

OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index ended the week down 0.2% at 7,882 having closed at a record high of 7,911 on Thursday.

Economics

The UK economy stagnated in the final quarter of last year, recording no growth and leaving GDP unchanged from the third quarter. A rise in business investment and consumer spending was offset by poor export numbers
Data published at the same time show that the UK economy shrunk by 0.5% from November to December due in part to a 1.2% fall in the consumer-facing services sectors
UK house prices were unchanged from December to January, according to estimates from Halifax; this follows four months of decline
The UK Treasury and Bank of England are developing plans for a digital currency that would ensure public control of the payments network
Euro area retail sales volumes fell by 2.7% from November to December as consumers faced high inflation
German industrial production fell by a greater than expected 3.1% in December, driven by a sharp drop in output among energy-intensive sectors
Investors are expecting a continued fall in US inflation when US CPI numbers are published tomorrow
US Fed chair Jerome Powell warned that interest rates may need to rise more than expected
The US consumed 6% less oil in 2022 than in 2019 and will further reduce its consumption in 2023 and 2024, according to forecasts from the US Energy Information Administration
The UK signed a trade agreement with Italy, the first such deal with an EU country following Brexit

Business

UK railway union RMT rejected a revised offer that aimed to end disruptive strikes and called for fresh talks
UK nurses, ambulance workers, physiotherapists and university staff went on strike last week
Meta (formerly Facebook) is planning further job cuts, the FT reports
Shares in Alphabet, the parent company of Google, ended the week almost 8% down amid concern it was ceding ground to Microsoft which has already released a public version of a Bing search engine that uses ChatGPT-powered AI functionality
Commodities trader Trafigura faces a loss of as much as $577m from fraud after it discovered that shipments of nickel it had purchased did not contain any nickel
Entertainment giant Disney announced a plan to cut 7,000 jobs as part of a cost-saving plan. Following the announcement activist investors who had been pressuring the company signalled their approval with the plans
Credit Suisse announced losses of $7.9bn last year, its worst year since the global financial crisis
Oil major BP announced record profits of $27.7bn last year

Global and political developments

The death toll in the earthquake that hit Turkey and Syria on 6 February has surpassed 25,000. UN emergency relief coordinator Martin Griffiths said that he expects the final death toll to more than double
Ukrainian president Volodymyr Zelenskyy visited London, Paris and Brussels last week as he sought fresh support from European allies. The UK is considering providing jet aircraft to Ukraine and said it would begin training Ukrainian pilots
Ukraine issued a fresh plea for more ammunition as it warned it expects a renewed large-scale Russian offensive
The US shot down a high-altitude flying object above Alaska. The origin of the car-sized object was uncertain. This follows the downing of a Chinese surveillance balloon in US airspace the previous week
The US placed six Chinese groups connected to the balloon on a trade blacklist
European Commission president Ursula von der Leyen said that the EU needed to broaden its strategy to deal with the economic effects of US subsidies for green energy to include the “massive subsidies” that China allegedly gives to business “in general”
The UK government announced it would split its business department into four separate departments in a bid to boost growth

And finally… researchers studying killer whales in the Atlantic Ocean found that killer whales who birth male calves are much less likely to reproduce again as they “pay a really huge cost to take care of their sons”. According to their research, when the mother dies the son normally dies within a year or two due to a large reduction in the amount of food it gets. Female killer whales are much less dependent on their mothers – fortunate sons

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