UK economy should narrowly avoid recession – EY ITEM Club

The UK’s economic growth prospects have been downgraded again in the latest EY ITEM Club forecast, published today.

However, the Summer Forecast says that the UK should narrowly avoid a recession – provided there are no further energy price shocks and the Bank of England doesn’t tighten monetary policy too quickly.

The EY ITEM Club forecasts UK GDP to grow by 3.7% this year, down from the 4.1% predicted in the spring, followed by 1% growth in 2023, a downgrade from 1.9%.

As inflation falls back, the EY ITEM Club expects the economy to expand 2.4% in 2024, slightly faster than previously predicted (2.2%).

The EY ITEM Club’s downwards revisions are prompted by the continued squeeze on households’ real incomes from higher inflation, ongoing supply chain disruption, borrowers facing the consequences of a series of interest rate rises and the rise in asset prices during the pandemic now subsiding.

Hywel Ball, EY UK chair, said: “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 supports to help the economy eke out growth over the rest of the year and avoid a recession.

“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.”

The Summer Forecast says that business investment is unlikely to return to its pre-pandemic levels on a sustained basis until 2025. The EY ITEM Club’s business investment forecast for 2022 has been cut again from 10% in May to just 6.4% now – half the 12.8% growth expected back in February’s Winter Forecast.

Meanwhile the EY ITEM Club says 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. Consequently, the EY ITEM Club expects the MPC to raise interest rates to 2% by the end of 2022.

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.

The EY ITEM Club 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.

The tenth edition of EY’s Future Consumer Index, published last week, found that nearly half (46%) of low-income respondents said that they felt financially worse off compared to February this year. Forty-four per cent (44%) of this group expect their financial situation to be worse in 12 months, while just 15% of high-income consumers expect to be financially worse off over the same timeframe.

Martin Beck, chief economic advisor to the EY ITEM Club, says: “Although households are experiencing a significant squeeze, there are factors helping to relieve some of the pressure. Job security provided by unemployment being at a near-50-year low and a candidate-friendly jobs market should give consumers more confidence in saving less and borrowing more. Meanwhile, higher-income households are responsible for an outsized share of consumer spending, and this group is best placed to deal with cost of living pressures thanks to savings accumulated in the pandemic. At the other end of the scale, the extra fiscal support announced by the Government after the last forecast in May will go a significant way to protecting some of those on low incomes from rising energy bills.

“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.”