EY: Recession likely to be deeper than expected

EY: Recession likely to be deeper than expected

Fears grow of a worse recession than previously thought as experts predict lower GDP growth for the next three years.

Amid a combination of high inflation, falling real incomes, rising interest rates, and tighter fiscal policy, experts at big four firm EY have downgraded UK GDP growth projections for the next three years, with warnings that a recession is likely to prove deeper than previously expected.

The EY ITEM Club’s Winter Forecast says that the UK economy is now expected to contract 0.7% in 2023, bigger than the 0.3% contraction predicted in October. 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% to 1.9%.

Growth of 2.2% is expected in 2025, down from the previously forecast 2.3%. The UK economy is expected to have grown 4.1% 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.

GDP growth in November 2022 means it’s now more touch-and-go whether a recession began last year. However, the challenging outlook suggests that GDP is likely to shrink over the first half of 2023.

That 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. The EY ITEM Club adds that this downturn should prove less damaging for the economy – and shorter – than downturns in the 1980s, 1990s, and 2000s. This is due to the unusual and externally driven nature of the recession, combined with the prospect of inflation falling back quickly this year. Nevertheless, the economy is not expected to regain its pre-pandemic size until the middle of 2024.

EY: Recession likely to be deeper than expected

Hywel Ball

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. 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.”

Inflation should fall significantly this year

Analysts expect inflation to average 7.2% this year. The £500 increase in the energy price guarantee and a likely increase in the weight attached to energy in the consumer spending basket the ONS uses to measure consumer prices are expected to add around 0.7ppts to inflation in April.

However, while inflation in 2023 will be high by historical standards, it is likely that we’ve already passed the peak with inflation reaching 11.1% last October. Inflation is forecast to fall to just under 4% by the end of this year, partly reflecting recent falls in commodity and shipping prices and the reduction in the cost of wholesale gas.

On a calendar year basis, average earnings are forecast to trail average inflation until next year, when earnings are predicted to grow 2.6% and inflation is expected to average 2.3%. Average earnings are expected to grow at half the average inflation rate this year, at just 3.6%.

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% in the spring.

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

Positively, the impact on unemployment is expected to be limited when compared to previous downturns. A tight jobs market and evidence of worker shortages in some sectors suggests some employers may opt to hold onto workers and reduce vacancies instead. Unemployment is forecast to peak just below 5% this year.

The relatively modest rise in unemployment should help in limiting the forecast fall in house prices. Experts predict house prices will fall by 2.4% this year, with another fall of around 3% in 2024, thanks to the impact of significantly higher mortgage rates and the wider economic downturn.

Martin Beck, chief economic advisor to the EY ITEM Club, said: “We’re forecasting a relatively modest rise in job losses by the standards of past recessions, which should help limit some of the knock-on effects of the downturn.

“Importantly, 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. Overall, we think that average property prices will fall by around 10%, from peak to trough, over the next 12-18 months.”

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