Recession likely to be deeper but not longer, says EY

The latest report from the EY ITEM Club has predicted a 0.7 per cent contraction in UK GDP — a downward revision from the 0.3 per cent contraction it forecast in its October’s autumn forecast.

It would mean that 2023 would be the first calendar-year economic decline for the UK since 2009.

Additionally, the report said there are significant risks, both positive and negative, to the forecast, particularly around energy and house prices.

A combination of high inflation, falling real incomes, rising interest rates, and tighter fiscal policy is the primary drags on growth. 

The impact of tighter fiscal policy and a deeper downturn, particularly on business investment, means the growth forecast for 2024 has also been downgraded from 2.4 per cent to 1.9 per cent. Growth of 2.2 per cent is expected in 2025, down from the previously forecast 2.3 per cent. The UK economy is expected to have grown 4.1 per cent in 2022.

Key factors behind the downgrade for the 2023 forecast include the reduction in the generosity of the Energy Price Guarantee, additional taxes on high earners and unearned income coming into effect from the spring and signs that the housing market is slowing faster than many had anticipated.

However, the report said the UK economy is still expected to return to growth in summer 2023 and into 2024 as inflation falls back and consumers use strong balance sheets to save less and spend more.

It added that this downturn should prove less damaging for the economy — and shorter — than downturns in the 1980s, 1990s, and 2000s due to the unusual and externally driven nature of the recession combined with the prospect of inflation falling back quickly this year.

Hywel Ball, EY’s UK chair, said the UK’s economic outlook has become gloomier than forecast in the autumn and the UK may already be in what has been one of the mostly widely anticipated recessions in living memory.

“The one silver lining is that, despite being a deeper recession than previously forecast, it won’t necessarily be a longer one,” he said.

“The economy is still expected to return to growth during the second half of 2023 and has been spared any significant new external shocks in the last three months from energy prices, COVID-19 or geopolitics. Meanwhile, the chief headwind to activity over the last year — high and rising inflation — may be starting to retreat, while energy prices are falling too.”

As the inflation outlook becomes less concerning, the EY ITEM Club thinks it is likely that the monetary policy committee will press pause on its rate hiking cycle soon with Bank Rate expected to peak at 4 per cent in the spring.

A modest rise in unemployment means the housing market should avoid a serious correction.

Positively, the EY ITEM Club expects the recession to have a relatively limited impact on unemployment when compared to previous downturns. A tight jobs market and evidence of worker shortages in some sectors suggest some employers may opt to hold onto workers and reduce vacancies instead.

Martin Beck, chief economic adviser to the EY ITEM Club, said the combination of more people holding onto their jobs and greater forbearance by lenders such as switching mortgage holders to interest-only deals should reduce the risk of forced home sales.

The winter forecast also predicted that consumer spending is likely to fall 1.4 per cent this year with growth of 2.3 per cent expected in 2024.

“In theory, households drawing on the savings accumulated during the pandemic period could help mitigate the impact on consumer spending from high inflation, real wage reduction, and job losses,” Mr Beck said.

“However, the latest data signals some reluctance among consumers to do so, suggesting that, for now, consumers are more concerned about their own financial prospects. But as the economic outlook brightens later this year, we think consumers will show a greater appetite to save less and borrow more.”