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UK economic growth downgraded but set to narrowly avoid recession

·Business Reporter, Yahoo Finance UK
·4-min read
General view of the skyline of London from Wimbledon, UK
The UK is expected to narrowly avoid a recession provided there are no further energy price shocks, and the Bank of England (BoE) does not tighten monetary policy too quickly. Photo: Reuters/Matthew Childs

The UK economy is forecast to grow 3.7% this year, and 1% in 2023, a downgrade from May’s 4.1% and 1.9% expectations.

According to latest EY Item Club data on Wednesday, the downward revisions come thanks to the continued squeeze on households’ real incomes from higher inflation, ongoing supply chain disruption, and interest rate hikes.

However, Britain is expected to narrowly avoid a recession, the report revealed, provided there are no further energy price shocks, and the Bank of England (BoE) does not tighten monetary policy too quickly.

EY upgraded growth expectations in 2024, from 2.2% to 2.4%, in the spring as the economy is set to make up for lost ground, and inflation is predicted to fall back.

The summer forecast said that business investment was unlikely to return to its pre-pandemic levels on a sustained basis until 2025.

Business investment forecast for 2022 has been cut again from 10% in May to just 6.4% – half the 12.8% growth expected back in February’s winter forecast.

Read more: FTSE hits three-week high amid expected resumption of Russian gas flows to Europe

“The outlook for the UK economy has become substantially gloomier than it was in the spring, but – while there are significant risks – the forecast suggests there should still be enough support to help the economy eke out growth over the rest of the year and avoid a recession,” Hywel Ball, EY UK chair, said.

“The challenges are spread across the economy, with both consumers and businesses under pressure. Business investment continues to under-perform expectations and subdued growth prospects, rising costs and increasing debt, particularly among small and medium-sized companies, mean a turnaround looks unlikely in the short-term.

“Investment is still far below the levels seen prior to the pandemic, despite the relaxation of pandemic restrictions and government incentives.”

It comes as UK inflation soared to 9.4% in the 12 months to June, up from 9.1% in May, and slightly ahead of expectations thanks to rising prices for motor fuels and food.

Transport made the largest upward contribution to the change in the CPI annual inflation rate with a rise in motor fuels offsetting a decline in second-hand car prices. Food and non-alcoholic beverages along with restaurants and hotels also pushed inflation higher.

Watch: How does inflation affect interest rates?

EY said on Wednesday that inflation is now likely to peak at 11% in the autumn and average 8.7% over the course of 2022.

“This implies a more intense squeeze on households’ spending power than expected in the Spring Forecast when inflation was expected to peak at 8.5% and average 6.7% this year,” it said.

It now expects the BoE’s monetary policy committee (MPC) to raise interest rates to 2% by the end of this year.

EY added: “Despite high inflation, the consumer sector still enjoys some potentially sizeable support from low unemployment, record high job vacancies and healthy household balance sheets, notably the big unplanned savings built up by many consumers during the pandemic.

“The paying down of unsecured debt over 2020 and 2021 has also created space for some households to borrow to maintain spending in the face of rising prices.”

Read more: UK workers suffer record drop in real terms pay

It also expects consumer spending to rise 4.1% this year, with 0.8% growth pencilled in for 2023 – both forecasts have been downgraded from May, when consumption was forecast to grow 4.9% in 2022 and 1.5% in 2023.

Average earnings are forecast to rise 5.5% in 2022, with workers still on course to see the biggest decline in real pay since the late 1970s. On a calendar-year basis, the EY ITEM Club expects earnings to fall short of inflation until 2024.

Martin Beck, chief economic advisor to the EY ITEM Club, said: “There are some significant risks to growth which could prevent the economy from meeting the forecast, not least the prospect of further supply shocks, whether in energy markets or the ongoing impact of COVID-19 on supply chains.

“A monetary policy overreaction to inflation is a key risk too, and the UK economy’s current relative weakness means the Bank of England’s monetary policy committee has been right to take a more cautious approach to raising rates than other central banks.”

Watch: Will interest rates stay low forever?