Mid-Year Outlook 2023
Explore our “Mid-Year Outlook”, the investment strategy update from Barclays Private Bank.
Macro - UK
By Henk Potts, London UK, Market Strategist EMEA
Please note: All data referenced in this article is sourced from Bloomberg unless otherwise stated, and is accurate at the time of publishing.
The prospects for the UK economy looked despairingly gloomy at the end of last year. A cocktail of political turmoil, monetary and fiscal tightening and a cost-of-living squeeze had economists predicting that a prolonged recession was imminent.
Confidence was restored, however, as Rishi Sunak’s new administration set about stabilising the nation’s finances and stimulating growth. The Bank of England now forecasts that the domestic economy will avoid a slowdown this year, and that gross domestic product (GDP) will be 2.25% larger than it had predicted back in February, by mid-2026.
While the worst of the downturn may be averted, growth prospects remain very weak. Indeed, the range of troubles facing the economy means that a shallow “technical” recession, or two consecutive quarters when growth slows, looks likely.
The UK economy beat the odds by expanding by 0.1% in the first three months of the year (Q1)1. That said, momentum shows signs of easing as GDP shrank by 0.3% in March2. Services had a poor month (-0.5%) but industrial production (0.7%) and construction (0.2%) both registered gains.
Demand for services may have been hit by periods of poor weather and industrial action. However, a broader-based weakening could be detected.
Elevated levels of inflation and higher mortgage rates are eroding household’s real disposable incomes, and constraining spending power. Private consumption nudged up 0.1% in Q11, while retail sales volumes slipped by 0.9% in March3. Consumption growth looks set to remain weak, averaging just 0.2% this year and 0.3% in 2024 (see table), compared to the 5.6% increase recorded in 2022.
The UK’s labour market still looks tight by historical standards, giving employees the whip hand in wage negotiations, but there are indications that conditions may have started to cool. Unemployment has been rising for several months, the number of paid employees is shrinking, job vacancies are gradually declining and pay growth is forecast to moderate.
UK unemployment ticked up to 3.9% in Q14 and the number of salaried staff fell by 136,000 in April, the first decline since February 20215. The number of job vacancies is still close to the 1.1 million mark5, or 31% above pre-pandemic levels, but has fallen for 10 consecutive quarters5.
The government has been trying to incentivise people, particularly the over 55s, who have ‘retired’ only recently to return to the workforce. In other words, the supply of labour is slowly starting to improve. Economic inactivity decreased by 0.4%in Q1, to 21%5, which will come as a welcome relief to human resources departments.
Average total pay surged by 5.8% in Q15 year-on-year (y/y), driven largely by wage hikes in finance and business services sectors, followed by construction. However, real pay, which is adjusted for inflation, slumped by 3%5, the second-worst fall since 2001, when records began. Average annual private sector pay accelerated to 7% in the three months to March5.
Given the economic weakness that potentially lies ahead, unemployment rates will probably steadily rise over the next 18 months and finish 2024 at 4.5%. In addition, the Bank of England (BoE) believes that private sector wage growth should slip to 5.5% at the end of this year, and be at 3% over its forecast horizon, as lower inflation eases pay demands6.
The dramatic increase in interest rates since the start of last year, of 4.25 percentage points7, has hit the UK property market. House prices came under pressure as mortgage rates surged, affordability measures were stretched and banks became more reticent to lend. The combination of tighter lending standards and more nervous buyers led to a 30.5% drop in mortgage approval rates in February, compared to the average level seen in 20228.
More recently, there have been signs that home prices are stabilising. After seven consecutive months when the value of residential property eased, monthly prices rose in April, although the annual figure dipped by 2.7%9.
Looking ahead, we do not expect the UK housing market to register dramatic falls over the next year, with a peak-to-trough decline unlikely to be more than 10%, as mortgage rates seem likely to plateau and resilient labour markets aid the ability of homeowners to meet mortgage payments. More structurally, supply-and-demand imbalances should provide further downside protection, particularly for the most desirable properties.
The lack of a recession and a higher tax take have improved the fiscal outlook. However, the modest uptick should not be interpreted as an optimistic sign. The borrowing requirement is likely to ascend over the next few years, although more slowly than previously projected.
Public sector receipts were £88.8 billion in March, 2.3% more than in the same period last year10. However, spending rose by 20% y/y to £110.3 billion10, reflecting the cost of the energy-support schemes. The shortfall between higher tax receipts and the extra government spending resulted in the UK having to borrow an additional £21.5 billion10.
The dramatic rise in inflation has increased the interest payable of index-linked gilts which increased by 46.9% in the fiscal year ending in April 2023, compared to the same period last year. The UK’s debt-to-GDP ratio currently stands at 99.6%10, the highest since the 1960s.
The sunnier economic picture allowed the chancellor to spend more, at least in the short term, and to cut taxes. The main change was to allow businesses to fully expense investments over the next three years.
In the medium term, the fiscal outlook continues to be constrained. The freezing of income tax thresholds and the hiking of corporation tax rates are expected to up the tax burden to 37.7% of GDP in 2027-28, which would be the highest since the second world war11.
Unfortunately, UK inflation continues to power ahead of many of its advanced-economy counterparts. That said, the headline consumer price index (CPI) finally fell into single digits in April, at 8.7%12, thanks to last April’s surge in energy costs falling out of the calculations.
One of the reasons for the UK’s racy inflation profile is the country’s dependence on natural gas for power generation. The government policies introduced to help shield the economy from higher energy bills, and the disruption caused to the supply of goods and labour following Brexit, have not helped either.
The 8.7% y/y increase in the CPI, and 6.8% y/y lift in core price pressures12, in April were above expectations. The monthly inflation report revealed that food inflation was running at 19.1%12, services inflation was still elevated and disinflationary pressures in non-energy industrial goods had stalled. The BoE now believes that inflation will stay higher for longer and projects that CPI won’t be back at the 2% target level until the start of 20256.
While inflationary pressures might be more persistent then previously projected, the trajectory of price increases finally looks to be more benign. Base effects, from the different measurement period, lower energy prices and a slowdown in services inflation should all start to erode the year-on-year comparison.
Overall, annual average headline inflation is forecast to hit 7% y/y in 2023, and 2.7% y/y in 2024. For core inflation, the average is expected to reach 5.9% y/y this year, and 3.3% y/y next year (see table).
The Monetary Policy Committee (MPC) has hiked rates for 12 consecutive meetings12 pushing its benchmark lending rate up from 0.1% in December 2021 to 4.5% in May, its highest since 2008.
At May’s MPC meeting, policymakers left guidance on the future path of interest rates unchanged, so keeping their options open. Policymakers identified more evidence of persistent inflationary pressures (as determined by the evolution of the labour market, wage growth and services inflation) that could lead to further rate hikes.
The base rate seems likely to be nudged up by another quarter of a point at both the June and July meetings, the latter probably being the last in the current rate-hiking cycle, taking the terminal bank rate to 5.0%. Rates are likely to be held until well into 2024. While rate cuts are possible next year, any such move is unlikely to occur until late summer. A barrage of quarter-point rate reductions is then predicted to take the base rate to 4% at the end of 2024.
UK activity has been supported by resilient global growth, lower energy prices and the fiscal support which was offered in the Spring Budget. Low levels of unemployment have left households feeling relatively secure and the expected increase in precautionary saving has not materialised.
However, there is no escaping the impact of the aggressive rate hikes, the squeeze on consumer spending power and the medium-term fiscal tightening. As such, the UK economy is predicted to nudge up 0.1% this year, skirting a recession, and deliver only a tepid recovery in 2024, with inflation-adjusted GDP nudging up by 0.4%.
Explore our “Mid-Year Outlook”, the investment strategy update from Barclays Private Bank.