UK to swerve recession as inflation slows

The UK will avoid a recession despite the impact of the Bank of England’s (BoE) interest rate hikes, new forecasts from the EY (Ernst & Young) Item Club say. In its new autumn forecast, EY predicted the UK economy would grow 0.6 per cent over the course of 2023, up from the 0.4 per cent growth that was projected in July.

The economy has been far more resilient to the Bank’s interest rate hikes that many experts predicted thanks to a remarkably strong labour market and a fairly rapid fall in energy prices. Businesses’ investment has been significantly stronger than expected and EY expects investment growth across the year to hit 5.9 per cent. Excluding the post-pandemic bounce, this is the fastest rate of growth since 2016.

EY also noted that households had received a net benefit from higher interest rates, as the return on higher savings rate offset the increase in mortgage payments. However, this trend is expected to reverse next year, and looking into 2024, EY downgraded its expectations. It now expects the UK economy to grow at 0.7 per cent, down from a prior estimate of 0.8pc.

Despite the downgrade and mounting cost of debt, the UK remains on track to avoid a recession. “A likely end to rate increases at the Monetary Policy Committee’s (MPC) last meeting, combined with falling inflation and a return to real pay growth, should keep the economy from falling into recession,” the EY Item Club said.

Hywel Ball, the EY UK chair, said: “The cost of debt is set to be the biggest headwind for the UK economy over the next 12 months, with consequences for both businesses and consumers.

“But while high interest rates will weigh heavily on growth, there are still signs of resilience from which we can take positives. Inflation is heading in the right direction, average wages are rising in real terms once more, and household and corporate balance sheets remain unusually healthy,” Ball said.

Inflation fell to 6.7 per cent in August – and did not rise in September – surprising economists who had been expecting a slight increase on July’s 6.8 per cent. EY suggested that inflation could fall to 4.5 per cent by the end of this year before hitting BoE’s two per cent target in the second half of next year. Interest rates will not have to go any higher, the firm predicted.

The forecasts come shortly after predictions from the International Monetary Fund (IMF), who said the UK will be the weakest performing major economy next year. The IMF expects the UK economy to grow 0.6 per cent next year, revised down from a previous forecast of 1.0 per cent.

While energy costs were expected to contribute to strong price growth in September, easing food inflation – as has now happened – will bring the annual rate of inflation to around 6.5 per cent, experts predicted.

Chief UK economist at Deutsche Bank, Sanjay Raja, said measures of food inflation had “all softened yet again.” British Retail Consortium data showed food price inflation fell to 9.9 per cent in September, the lowest level in a year. Kantar data also showed a marked drop in grocery price inflation in September.

However, Chief UK economist at Investec, Philip Shaw warned, that “there are certainly upside risks”, some of which “may already be crystallising.” He pointed to a surge in wholesale energy prices, driven by supply cuts, damaged pipelines and geopolitical tension. In mid-October, gas prices jumped to their highest level since June after one of Israel’s largest gas fields closed.

Developments in inflation will be crucial to informing the BoE’s next interest rate decision in November. The Bank left interest rates on hold in its most recent meeting, meaning the benchmark Bank rate stands at 5.25 per cent. (The writer is our foreign correspondent based in the UK)