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IF Insights: Predicting the road ahead for UK economy

IFM_UK Economy

For the time being, the United Kingdom economy contracted in May and June as industrial output slid month over month, a signal that rising Bank of England interest rates are weighing on economic activity.

However, Gloomier expectations have given way to a more optimistic perspective. The Bank of England (BoE) and the International Monetary Fund (IMF) reduced their forecasts for the economy to contract in 2023 for at least six months.

Consumers’ buying habits have been far more durable than projected. Wholesale energy prices have also dropped, easing pressure on corporate and household budgets.

The country will avoid a recession

Amid the subdued economic activities, the best-case scenario for the United Kingdom will be escaping the demon called ‘recession’ and growing by roughly 0.1% in 2023. This scenario anticipates no geopolitical upheavals and that the country will benefit from the ‘dullness’ of a return to more regular domestic and international settings with a low level of policy uncertainty.

In our worst-case scenario, International Finance assumes that one or more of the dangers to the UK economy materialize. The most obvious risk is that inflation will remain stubbornly high, either due to geopolitical developments or rising wage, service, or food inflation. There might be widespread and protracted strikes in significant parts of the public sector along with this, which would mean missed work hours. According to this scenario, the UK economy will decrease by roughly 0.9% this year.

The country has seen no economic growth in three months, compared to the overall Eurozone.

Post-Brexit trade and vital sectors have continued to perform poorly, data from the Office for National Statistics (ONS) revealed, as industrial production activities continued to shrink.

Monthly GDP growth, measuring the total value of goods and services produced in a country, also fell by 0.1% in May after a brief rise of 0.2% in April.

Single-digit inflation in coming days?

The chances of inflation falling dramatically in 2023 are higher. The figure may return to single digits by the middle of the year and hover around 3–4% by the time 2024 arrives.

These forecasts take into account the fact that prior increases in energy and goods prices will be excluded from the annual computation, as well as the expectation that tradable goods inflation will remain low. Furthermore, tightening financial conditions are likely to have a greater impact on economic activity in the coming quarters.

Also as per the ONS, Britain’s public sector net debt surpassed 100% of GDP in May as borrowing came in higher than expected. Public sector net debt, excluding that of state-controlled banks, hit 2.567 trillion pounds (USD 3.28 trillion), equivalent to 100.1% of the GDP.

Economic inactivity will rise due to structural factors in the future decade. Since the start of the COVID pandemic, economic inactivity has remained high, owing primarily to health concerns and other issues.

Nonetheless, the pandemic’s impact obscures a larger concern that the UK economy will face in the coming decades: population ageing. All else being equal, we predict economic inactivity due to population ageing to rise by 2.4 million by 2030, with the 65+ age group accounting for 90% of this increase.

As a result, it is even more necessary for policymakers to continue enhancing the productivity of the existing workforce and for businesses to better define their recruitment tactics and products to appeal to and serve a broader population.

Tight labour markets and the ‘Brexit’ effect

Brexit is thought to have exacerbated the challenges of a tight labour market, particularly in key industries like healthcare. This has had a knock-on effect on another issue confronting the economy: a large number of long-term sick patients, as a lack of staff is likely to result in longer wait times for treatment.

With potential workers unable to work due to illness, there are fewer candidates for available positions, which keeps the labour market tight and has resulted in a quicker wage rise, adding gasoline to the inflation fire.

The Brexit effect is also visible in slower export figures as compared to other G7 countries such as the United States, France, Germany, Italy, Japan, and Canada.

What does all of this imply, and what happens next?

Consumer prices rose 7.9% in June 2023 compared with the same period in 2022.

“Core inflation, which strips out volatile food and energy costs and is a better gauge of the underlying trend in prices, came in at 6.9%, down from 7.1% in May, which was the highest rate in 31 years,” stated a CNN report.

Food price inflation also fell to 17.3% from 18.3% in May 2023. Annual services inflation too is on the downward path.

However, rising inflation has been eroding eating into wages and pay increases are proving inadequate for the common Brits. To make matters worse, due to the rising interest rates, mortgages and loans have become expensive, adversely affecting household finances and companies’ profit margins.

Over two million mortgage holders are bracing for a sharp increase in their monthly repayments when they have to refinance fixed-rate deals.

The National Institute of Economic and Social Research also sees savings of over a million households wiping out by the 2023 end due to higher mortgage bills.

There’s a chance that inflation will decline considerably faster than markets think, which means interest rates won’t have to increase as much as some have predicted. The drop in oil costs trickling through to inflation readings will help, potentially resulting in a softer landing for the economy.

There are also some hints of a shift in the tide when it comes to pay increases, with real-time pay statistics indicating that salary growth is slowing.

Some pre-election freebies, such as tax cuts and spending pledges, could potentially boost output.

However, given some of the fundamental challenges that continue to plague the UK, a significant rebound in growth is unlikely to occur anytime soon.

Conclusion

Economic inactivity is expected to rise in the coming decade due to population ageing, necessitating efforts to enhance workforce productivity and adapt business strategies to cater to a broader population.

Brexit has added complexity to the tight labour market, particularly in crucial sectors like healthcare, leading to longer wait times for treatment and higher wage inflation. The impact on exports has also been evident compared to other G7 countries.

Despite some positive signs, it is unlikely that the UK will experience a significant rebound in growth shortly, given the fundamental challenges that persist. As of now, the only positive news is that inflation may decline faster than anticipated.

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