UK Economy Beset By Sluggish Growth and High Inflation

Main points

• The labour market remains strong; however, because of anemic 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.
• Despite higher interest rates, there has been a significant increase in business and consumer confidence across a range of survey and sentiment indicators. This may seem surprising against a backdrop of increasing interest rates and high inflation. However, it may be better to characterise this reported increase in confidence as a collective sense amongst business and consumers that, perhaps, the worst of the energy price shock is behind us.
• The labour supply shortage and the chronic investment deficit remain. We feel the budget measures were a step in the right direction but insufficient to deliver the needed structural changes to encourage a return of stronger productivity growth to the UK economy.

With King Charles crowned last weekend, it feels like a new era is on the horizon for the United Kingdom. Indeed, in the period between our Winter and Spring Outlooks the UK economic outlook has improved a little, with a recession in 2023 now looking less likely. But the UK economy is still facing the problems of sluggish growth and high inflation and while the Chancellor’s Spring Budget of 15 March contained a number of policies that represented steps in the right direction, there was not the fundamental shift in the direction of public investment that will be needed if UK productivity growth is going to return to anything like pre global financial crisis rates.

Nonetheless, there is some reason for optimism. As noted in our April GDP Tracker (Bejarano Carbo and Nowinska 2023), we now expect GDP 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. Looking further ahead, we expect sluggish growth in 2023 and 2024 of 0.3 and 0.6 per cent, respectively. At least to begin with, the third Carolean era is not going to herald a new dawn of high output growth.

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. NIESR continues to make the point that we should not be tied to the ‘two negative quarters of GDP growth’ definition when thinking about recessionary conditions but, rather, should be employing a broader definition along the lines suggested by, eg, the National Bureau of Economic Research (NBER) Business Cycle Dating Committee and the UK Business Cycle Dating Committee (Broadberry et al., 2022), who define a recession as a significant decline in economic activity spread across the economy, lasting more than a few months.

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. As discussed in our April 2023 CPI Tracker (Bejarano Carbo, 2023a), 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, and the likely higher wage inflation resulting, in part, from the current wave of industrial unrest, we continue to expect inflation to remain persistently above target. Specifically, we expect CPI inflation to fall only to 5.4 per cent by the end of 2023 and not reach the Bank of England’s target of 2 per cent until the third quarter of 2025 (figures 1.3 and 1.4). Although interest rate hikes may almost have finished, if core inflation remains high, interest rates may have to remain at their peak for a longer period than we and the markets currently anticipate, with implications for government debt interest costs and the debt to GDP ratio.

See our previous quarterly UK Outlook to follow the analysis.