UK economic outlook - Q3 2023

We believe that UK GDP will be flat or near flat for most of the year. Risks are to the downside. Chancellor Hunt recently stated that he would be comfortable with a recession, if it brings down inflation. Credit conditions should continue to tighten at least until at least the middle of mid-2024, and quite possibly beyond that. The general economic malaise in Europe also lowers the outlook for the UK. In terms of inflation, we feel that it will have fallen between 4% and 6%, with risks more to the upside (above 5%) than the downside. We expect unemployment to grow marginally, from 3.9% to 4.5%, as the core problems of the UK labour market, a deep mismatch between demand and supply of skills, are expected to persist. In this environment, we would expect interest rates to rise at least by another 0.75% from their present levels.

Consumption: UK consumers seem undeterred by rising costs. This invites policy reaction needed to bring down inflation.

Labour Market: The labour market remains tight, with the unemployment rate close to historic lows and wage growth too high to be consistent with the Bank of England's 2% inflation target. There are, however, positive signs: the participation rate is rising, and the number of migrant workers has reached the pre-pandemic, pre-Brexit trend.

Interest Rates: As inflation becomes entrenched, a localised as opposed to a global supply chain problem, central banks are poised to keep interest rates high. Meanwhile, banking stresses mean that the financial system will further tighten credit.

Inflation: We see disinflation on the horizon. We expect inflation to continue to fall over the coming months and end the year around 5%. Our optimism is based on the fact that international energy and food prices have fallen significantly over the past year and that they feed through to the UK CPI with a lag of 6-9 months.

Real Estate: Contrary to market expectations, the downward trend in house prices slowed and even reversed in April and May, with most house price indicators showing monthly increases. Despite this, and the tight supply of new homes, we expect prices to fall further over the year as mortgage rates rise again.

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