RECESSION IS HERE AS THE COST OF LIVING CRISIS, TIMID TRADE, AND HIGH PRICES DAMPEN GROWTH

As with many other countries in Europe and worldwide, the economic consequences of the war in Ukraine affected the United Kingdom in 2022 and will continue to do so in 2023. With gas being essential to the country’s energy composition, high energy prices have been particularly prominent. Supply chain constraints and increased energy and commodity prices caused much of the rising inflation in 2022. As some of these eased somewhat in the last months of the year, they were succeeded by second-round effects that led to broad-based inflation. These inflationary pressures include higher core inflation (6.3 % in November 2022), pent-up price hikes for businesses (producer input inflation rose more than double that of consumer price inflation during most of 2022), and anticipated higher pay rises. Inflation is expected to fall gradually over 2023 as global factors weaken. However, due to domestic pressures, inflation will remain well above the Bank of England’s (BoE) 2 percent target. The falling inflation rate will mean a slowdown in interest hikes by the Bank of England (BoE) after eight walks in 2022 alone, concluding with a 50 basis point uptick to 3.50% in December 2022. Interest rate hikes are expected to peak in the first half of 2023 above 4% (around 4.25-4.50%) and remain at this level until the end of the year. Pay rises were, and are, not expected to be at the same level as inflation, which in 2023 will result in households’ natural disposable income falling, meaning that private consumption will be suppressed in 2023. This is despite the energy support measures (GBP 2,500 energy cap until March 2023 and GBP 3,000 until March 2024), cost-of-living measures for the most vulnerable, the rise in pension payments (+10.1% in April 2023) and increased minimum wage (+9.7%). While savings ratios are slightly above the pre-pandemic levels, the savings households accumulated during lockdowns are gradually being drawn on due to higher living costs, meaning families will lower their consumption in 2023. Capital investments by businesses are expected to fall in 2023, especially in the construction sector, due to economic uncertainty and a challenging investment environment with labor constraints, high production costs, and high-interest rates, with the latter raising financial prices and limiting demand. At the same time, the Capital Allowances “super-deduction” will end in March 2023, and the corporation tax will rise from 19% to 25% (for companies making more than £250,000) in April 2023. Exports, which remained 5% below pre-pandemic levels in Q3 2022, will continue to be affected by the consequences of exiting the EU (border checks), especially as its main partners - the EU (around 40% of exports) and the US (14%) - will also experience a challenging year in 2023. Yet, net exports contribution is likely positive, as imports will fall due to lower domestic demand. After the end of support measures, insolvencies have been on an upwards trend since mid-2021, with the level in 2022 being 26% higher than in 2019 and 57% over 2021 levels. With a decreased demand and increased operational and financial costs, insolvencies are anticipated to rise even higher. All the more so as the Energy Bill Relief Scheme (fixed maximum price) will be replaced by a less generous support scheme, Energy Bills Discount Scheme (subsidy per MWh), from April 2023, making businesses more vulnerable to a very volatile energy market.

STABLE FISCAL POLICY IN RESPONSE TO RISING DEBT FINANCING COSTS

A revised Autumn Statement in November that mainly focused on tax rises and spending cuts was a reversal from the “mini-budget” revealed only two months prior. Although lower than in 2022, the public deficit will remain above the pre-pandemic levels. The Statement included several energy and cost of living support measures for households (+ GBP 25 billion, 1.1% of GDP) as well as some support measures for public spending (+ GBP 7.8 billion, 0.4% of GDP), such as further funding for NHS, social care and education. Two months later, the Government announced the Energy Bills Discount Scheme (+ GBP 5.5 billion, 0.2% of GDP). Higher taxes will only partially count these expenses, mainly related to corporates, such as windfall taxes on extraction companies and electricity producers and other business taxes (+ GBP 7.1 billion, 0.3% of GDP). Therefore, public debt will continue to rise. Financing costs remain elevated due to political turmoil, inflation, and BoE’s policies. Rising inflation has further affected the budget, as inflation-indexed bonds comprised around 25% of the debt and were almost 60% of debt interest payments in November 2022. In August 2022, the BoE announced its intent to start selling some of its holdings of Government Bonds (Gilts). It was initially reported that it intended to reduce its total gilt holdings by GBP 80 billion from September 2022 to September 2023. However, this was delayed by two months due to the passing of Queen Elizabeth II and the financial turmoil following the “mini-budget.” The BoE intends to sell GBP 3.25 billion worth of Gilts in each short, medium, and long maturity sector (GBP 9.75 billion) every quarter, with the remainder of the balance sheet reduction achieved by not reinvesting maturing bonds.

The current account deficit is expected to narrow slightly compared to 2022. However, this was a great year as high energy costs substantially affected increasing imports. Due to energy costs easing in 2023 and lower domestic demand, imports are expected to fall, narrowing the balance of goods deficit. Meanwhile, it remains the case that the country has a positive balance of services, partly due to its place in the global financial and insurance industry, which will partially cover some of the balance of goods deficit. The country comfortably finances its current account deficit through foreign portfolio investments as a central place in the international financial system.

POLITICAL STABILITY AS WE ADVANCE AFTER A TUMULTUOUS 2022

Rishi Sunak, the former Chancellor of the Exchequer in Boris Johnson’s Government, became Prime Minister on 24 October 2022, four days after the resignation of Liz Truss, to whom he had lost the bid to become conservative leader, and thereby Prime Minister, only three months prior. Liz Truss’ premiership was short-lived, 44 days in office, as the “mini-budget” presented by her Government was scrutinized both domestically and abroad, resulting in the GBP depreciating instantaneously, 10-Year Gilts yield rising rapidly and the BoE being forced to intervene in the bond market by temporarily buying UK Gilts. After Rishi Sunak was confirmed as Prime Minister, financial markets did stabilize. The Autumn Statement reaffirmed the new fiscal course, focusing on fighting inflation and sustainable public finances. The new Statement included some support measures and compensation increases for lower-income households. However, as real disposable income will fall along with the Government’s hard stance on striking, exemplified by the proposed ‘Strikes Bill,’ further strikes and some political tensions are expected. The wild streak of scandals from the Boris Johnson period and the financial turmoil during Liz Truss’ tenure has resulted in a weakened Conservative party which averaged around 25% of votes in polls compared to Labor, which averaged almost 50%, in December 2022. Therefore, the Prime Minister is unlikely to call an early general election – due to be held no later than January 2025 – in 2023; even so, further episodes of political instability cannot be ruled out. Rishi Sunak’s policy stance on the future trading relationship with the EU is less prominent. He is expected to be less aggressive than Liz Truss and Boris Johnson. This means that the current political strain between the UK and EU over the “Northern Ireland Protocol,” the trade mechanism that enables Northern Ireland to remain within the single market, might be easier for the new Government. An announced trade data-sharing mechanism between the parties on 9 January 2023 indicates this. Nonetheless, it should be highlighted that Rishi Sunak was and still is an adamant Brexit supporter.