Recession Avoided, But Prospects Remain Bleak for Households

Main points

• The labour market remains strong; however, because of anaemic growth, we forecast a slow rise in unemployment in the coming year, peaking at around 4.7 per cent in the third quarter of 2024.
• Our view remains that the participation rate for the working-age population will return to its preCovid level over the course of the next few years as workers in the 50-64 age group return to the labour force, as they find their savings run down, and fewer workers retire early.
• Higher interest rates mean higher costs on lending for businesses, increasing the risk of lower business investment. This may affect the longer-term growth and productivity prospects for the United Kingdom.
• The current monetary policy tightening cycle has been aggressive in terms of the pace and magnitude of rate hikes and, given the lags in monetary policy transmission, will likely bear down on output and growth in 2024. But the annual inflation rates we’ve seen throughout the course of 2022 have made this a necessity.
• Given the MPC received criticism for not tightening quickly enough, it is possible that they will loosen too quickly to avoid the converse criticism. Equally, if the MPC errs on the side of caution with the pace of its loosening, and in doing so, aggravates recessionary risks by more than is warranted they may also face criticism. Once the MPC starts loosening, we expect the interest rate to return to a more ‘normal’ (ie, pre-Financial Crisis) level. This is dependent on the rate at which inflation, and core inflation, fall.
• The freezes in income tax thresholds will lower personal disposable income and the corporation tax rises will likely reduce investment in the economy. However, the Chancellor has laid a path to be able to meet his fiscal targets with headroom to spare. As it stands, the Chancellor will get borrowing under 3 per cent of GDP and underlying debt falling as a percentage of GDP in five years’ time with £18.6 billion and £9.2 billion to spare, respectively.
• That said, public finances remain vulnerable to interest rate rises as well as further shocks to the economy. Indeed, the medium-term outlook for public finances has deteriorated since our Autumn Outlook due to a worsening outlook for GDP and higher inflation persistence. Having said that, a downward shift in the yield curve and the debt-devaluing effects of inflation will have contributed positively to the outlook for government finances.
• Although the political and economic turmoil of the autumn may have served as a warning to policymakers of the perils of reckless policy experimentation, we hope that this did not dilute the political will to conduct a necessary reform of this country’s fiscal framework, as NIESR has continuously recommended.

The UK will likely avoid a protracted recession in 2023, but GDP growth is set to remain close to zero. However, with the cost-of-living crisis having a lasting effect on households, for at least 7 million it will certainly feel like a recession.

Inflation continues to remain a concern for the 2023 outlook at both the macroeconomic and household level. Despite falls in the headline figure measures of ‘core’ or underlying inflation suggest that inflationary pressures are still present in the UK economy. We therefore anticipate that inflation will still be above 3 per cent at the end of 2024 and will not reach the Bank of England’s two per cent target until the third quarter of 2025.

The anaemic growth, and persistent inflation, continues to damage UK households. ONS data for 2022 Q3 show that real disposable income contracted for the fourth consecutive quarter, despite government assistance. We project that 7 million UK households (1 in 4) will be unable to meet in full their planned energy and food bills from their post-tax income in 2023-24, up from around 1 in 5 in 2022-23. Middle-income households, will face a hit to their personal disposable income ranging from 7 per cent to 13 per cent, reaching up to £4,000 in the financial year 2022-23.

As savings are run down, and fewer workers can afford to retire early, we anticipate that the participation rate for the working-age population will return to its pre-Covid level over the course of the next few years as workers in the 50-64 age group return to the labour force – though barriers remain at the level of employer attitudes to older workers and also chronic ill health.

See our previous quarterly UK Outlook to follow the analysis.