Economic trends
The UK government has made progress on rebuilding its reputation in the eyes of the financial markets, thanks to a return to an orthodox fiscal policy under the new Sunak administration. Having reached a low point of $1.07 on the 28th September 2022, the pound had rallied to nearly $1.24 on 27th January 2023. 10-year Gilt yields stood at 3.3% on 27th January, down from the 10th October peak of 4.5%.
In his Autumn Statement the Chancellor announced plans to eliminate a £55 billion a year gap in the government’s finances over the medium-term. Taxation will increase via fiscal drag, whereby thresholds are left unchanged. Also, spending for parts of government will rise by less than inflation. Most of the measures apply from 2025 onwards.
The UK economy is currently caught between the impact of high inflation, which is squeezing incomes, and the Bank of England hiking interest rates in order to tame price rises. Inevitably, the steps taken to tackle inflation have a negative effect on growth. UK GDP contracted q-on-q by -0.3% in Q3 2022, leaving the economy -0.8% below its pre-Covid level.
Recent months have seen the economy move into a ‘stop, go’ pattern, where GDP has alternated between growth and contraction on a month-on-month basis. September saw GDP shrink by -0.6% compared to August, but in October growth rebounded to 0.5%, then slowed to 0.1% in November. The surprise growth in November has greatly reduced the chances of a negative Q4 number.
Industrial action has become much more common in the last year, with the lost working hours and disruption further dampening growth. More strikes are expected in the coming weeks.
November saw the Services sector grow by 0.2% m-on-m, down from 0.7% in October. This was partly due to strong performances by the Administrative and Support Services and Information and Communication sectors; plus the FIFA World Cup tournament helped support the hospitality sector.
The Production sector fell by -0.2% m-on-m, due to a drop in output by the manufacturing sector which outweighed growth in Mining and Quarrying (which is dominated by North Sea oil and gas). In particular, the pharmaceuticals and chemicals industries saw significant falls.
The Construction sector saw flat growth in November m-on-m, as a fall in new work was counterbalanced by increased repair and maintenance jobs.
The war in Ukraine caused volatility in commodity prices and increased pressure on supply chains for much of 2022. However, there is now evidence the impact is easing with the oil price having peaked in the summer, while cargo rates have fallen markedly in recent months.
Public sector net borrowing was £27.4 billion in December 2022. This was £16.7 billion more than the same month in 2021, and the highest December borrowing figure on record. Total public sector debt stands at nearly £2.5 trillion, the equivalent of 99.5% of GDP.
1.1 The IHS Markit composite Purchasing Managers’ Index (PMI) for January 2023 recorded a net balance of 47.8, down from the 49.0 in December. A reading of below 50.0 suggests an economic contraction may have occurred.
1.1 The services sector PMI declined from 49.9 in December 2022 to 48.8 in January 2023. The manufacturing sector increased from 45.3 in December to 46.7 in January.
Bank of England data reported that consumer borrowing grew by £2.8 billion in December, which was down from the £5.5 billion figure recorded in November. Growth in unsecured lending, such as on credit cards, fell by -£461 million, although December 2021 also saw a negative figure.
Gfk's consumer confidence index stood at -45 in January, down from -42 in December, reflecting concerns over cost-of-living increases. This is very low by historic standards – the pre-Covid 10-year average was -12.8.
Retail sales volumes fell by -1.0% in December, with the decline seen in November revised downwards to -0.5%. The ONS reported receiving “continued feedback from retailers and other wider evidence that consumers are cutting back on spending because of increased prices and affordability concerns”.
Labour Market
1. The employment rate stood at 75.6% in the three months to November 2022, which is below the 76.6% figure recorded in February 2020 before the pandemic. This is due to a higher inactivity rate today. The unemployment rate was 3.7%, which is unchanged m-on-m but above the 3.6% seen in September. This is low by historic standards and indicates a tight labour market.
1.1 Although recent labour market indicators paint a positive picture, it should be remembered that employment figures are lagging indicators, and GDP growth slowing lately may point to a weaker jobs market ahead.
1.2 Indeed, there are some signs of a moderate slowing in labour demand, as the number of job vacancies has gradually eased in recent months to under 1.2 million in November, after peaking at 1.3 million in May. Regular pay growth currently stands at 6.4% in nominal terms, but is negative (-2.6%) in real terms. This is contributing to the household incomes squeeze this year.
Inflation
CPI inflation eased to 10.5% in the year to December 2022, down from 10.8% in November. Many commentators believe that inflation will now trend downwards, particularly as the October energy price cap increase is in the figures.
The government has announced a package of measures to cap the average household energy bill at £2,500 until April of 2023; then increasing to £3,000 to April 2024. This still leaves the consumer facing a doubling of their energy bill compared to last winter.
2022 saw market interest rates increase significantly, although they have eased to an extent in January 2023. The 5-year swap rate stood at 3.8% on 27th January 2023, compared with 4.3% on 30th December 2022 and 2.5% on 1st August.
Consequently, many commentators argue that the benefits to households from the energy cap and tax cuts are being counterbalanced by higher interest repayments on debt. This means the squeeze on household incomes is continuing and will weigh on growth through the winter.
At the February meeting of the Bank of England’s Monetary Policy Committee (MPC) the decision was taken to increase the UK base rate by 50 bps to 4.00%. We believe the base rates is now at or close to its peak for this hiking cycle.
For the UK property market, the higher base rate means that the cost of debt is no longer as favourable. Around three quarters of UK mortgages have fixed interest rates, so the increase is having a gradual impact on most homeowners at refinancing.
Outlook
While the risks to the UK economy from Covid are now negligible, the consumer squeeze and above-expectations inflation have hit GDP growth. Both central bank and market interest rates rose quickly during 2022, leaving debt more expensive and less available. This is expected to result in a recession in the near-term. Oxford Economics is currently predicting -0.7% GDP growth in 2022, then 1.6% in 2024 and 2.7% in 2025.
There is a widespread expectation that this recession will be much shallower than that seen in 2008-2009, as the current downturn does not contain the same systemic threats that were seen during the Global Financial Crisis.
On the plus side, a number of geo-political risks are playing out better from an economic perspective than many feared. There is less talk now of power cuts and energy rationing in Europe than just a few months ago. In Asia, the Chinese government has moved away from its zero Covid policy, which had previously been impacting supply chains.
Higher living costs in the UK, including ten interest rate hikes, are weighing heavily on the consumer side of the economy, particularly as pay growth is negative in real terms. According to ONS, consumer-facing services saw output shrink by -0.8% in Q3 – more than twice the rate of contraction seen by the wider economy.
Government bond yields increased significantly in 2022, which has increased the cost of servicing the national debt. It has also made borrowing more expensive for households and firms. This will further act as a brake on growth.
Inflation has probably now cleared its peak and should steadily retreat over the course of 2023. Oxford Economics is forecasting the base rate will now remain unchanged at 4.0% until the summer of 2024.
It is worth noting that for most major global economies there is concern over the outlook for growth. Inevitably, the rate hikes that central banks are implementing to bring inflation under control will slow economic growth. Given this is occurring at a time when growth is low in most advanced economies, many commentators believe the UK is moving into a recession that will last into the latter part of the year.
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