Sticky Inflation and Sluggish Growth: What Lies Ahead for the UK Economy

Recent UK data has been encouraging.  What are your views as to the prospects for UK GDP growth over the medium term?

There has indeed been some mildly encouraging news following the latest GDP estimates published by the Office for National Statistics (ONS).  GDP is expected to have grown by 0.1 per cent in the first quarter of 2023 and we expect GDP to grow a further 0.3 per cent in the second quarter of 2023. However, despite the positive news, we still expect sluggish growth in 2023 and 2024 with GDP growth remaining close to zero in both years.

While we are expecting the United Kingdom to avoid a ‘technical recession’ in 2023, the anaemic growth and ongoing ‘cost-of-living’ crisis, together with the possibility of rising unemployment, will lead many households to feel like they are ‘experiencing’ a recession.

Inflation has remained in double digits for a while now, when, and how quickly, is it going to fall?

UK inflation remains in double-digit territory and core inflation remains high. Twelve-month Consumer Price Index (CPI) inflation fell to 10.1 per cent in March from 10.4 per cent in February, but is being driven by food price inflation, which rose to 19.1 per cent, the highest in over 45 years. Headline inflation remains in double digits – the seventh consecutive month for which this has been the case – and the rate is still among the highest in four decades. Inflation also remains markedly above the Bank of England’s inflation target of 2 per cent and this is the 20th consecutive month for which this has been the case.

There are worrying signs that inflation is becoming more persistent. In March, CPI inflation excluding food, alcoholic beverages and tobacco remained flat at 6.2 per cent, while our trimmed-mean measure of CPI inflation rose to 9.9 per cent, the highest it has ever been.

As a result of the high and persistent core inflation, we expect Inflation to fall in 2023, but not as quickly as the Bank of England or the Office for Budgetary Responsibility (OBR) predict. We do not expect it to return to target until late 2025.

Last week the MPC raised rates by 25 basis points;  is that it for monetary policy tightening?  And how are interest rates likely to evolve over the next couple of years?

The Bank increased rates last Thursday by 25 basis points, reaching 4.5 per cent. The two big questions following that are whether we think that is the peak and will rates stay higher for longer. Well, to answer the first question, our forecast suggest that is indeed the peak – although there is every chance the Bank increases further. And to use Governor Bailey’s words, they “have to stay the course” – but staying the course could simply mean staying higher for longer which brings me to the next question. And, I think that with the persistence in core inflation the bank might indeed have to stay higher for longer in order to bring inflation back to its 2 per cent target.

Labour market inactivity continues to be an issue.  What has driven the rise in inactivity and will it persist?

Despite the marginal decrease in the inactivity rate from 21.3 per cent to 21.1 per cent, the workforce participation rate remains 0.9 percentage points lower than pre-pandemic levels – which is a cause for concern amidst the still relatively tight labour market.

Compared to the pandemic period where students and long-term sick explained the bulk of the high inactivity rate, the decrease driving the latest three-month period was largely among students and those aged 16 – 24 years. This might suggest that these groups are gradually joining/returning to the labour force as they continue to eat into their own savings amidst the ongoing cost of living crisis. However, the long-term sick remains the largest group within the inactive population and the number of long-term sick has reached its highest level since the start of the pandemic. The weakness in labour participation, in part reflecting ill health, may have exacerbated the tightness in the labour market.

The Chancellor made a number of announcements aimed at increasing labour participation and addressing labour market shortages, including discouraging early retirement through more generous pension allowances, and encouraging more women into the labour force by subsidising childcare costs and offering support to work. But we feel the Budget fell short of implementing a comprehensive targeted strategy to tackle the acute issue causing a tight labour market – the high economic inactivity rate. It is a clear priority to enable those people who want to work to return to the workforce, which will help alleviate some of the tightness in the labour market. In that light, it was disappointing that the Budget did not include measures aimed at the long-term sick such as further spending on the NHS to enable increased access for older workers to proper and timely healthcare.

Read our latest UK Economic Outlook here