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UK recession: Bank of England losing fight against inflation as economy starts to shrink

By Fitri Wulandari

Edited by Jekaterina Drozdovica


Updated

The Bank of England (BoE) building in London
Is the Bank of England losing its fight against inflation? – Photo: Shutterstock, Alex Yeung

The UK economy is caught in a whirlwind of soaring inflation that has remained at a 40-year high, a depreciating pound and monetary policy tightening, with the latest GDP reading showing the economy has started to contract.

The previous UK Prime Minister Liz Truss’s 44-day tenure from September to October aggravated the struggles. And it will be up to Rishi Sunak, the UK’s current Prime Minister, to steer the country’s economy back on course.

UK recession is unavoidable in 2023 but how long will it last? Let’s take a look at the latest UK recession news and economy forecasts.

What is a recession? 

A recession is a period of decreased economic activity; a ‘technical recession’ typically refers to a decline in gross domestic product (GDP) – the total of all goods and services produced – of at least two consecutive quarters. 

While each recession is distinct, they all share several common features, according to the International Monetary Fund (IMF):

  • A recession typically lasts about a year and results in a significant fall in economic output.

  • It is usually marked by a fall in GDP of at least 2%, though the drop in output can be nearly 5% in severe recessions.

  • The unemployment rate often rises and inflation falls slightly, because overall demand for goods and services is reduced.

  • International trade falls as exports and imports tumble during periods of slowing economic activity.

  • Industrial production and investment see much steeper declines than GDP, while consumption experiences modest declines.

Since 1955, the UK has experienced eight economic shocks when GDP fell between two and five consecutive quarters, according to the country’s Office for National Statistics (ONS). The last UK recession was during the 2008 financial crisis, when GDP declined for five consecutive quarters.

The Covid-19 pandemic and nationwide lockdowns in 2020 sent shockwaves throughout the British economy, with GDP falling by 19.8% between April and June 2020. 

However, the country’s GDP growth recovered to 17.6% in the third quarter of 2020 as restrictions were lifted. 

Is the UK in a recession right now?

The UK economy shrank by 0.3% in the three months to October 2022 compared with the three months to July, according to the ONS.

UK GDP HISTORY

“The silver lining of the unfolding recession is that it should help to bring inflation back to the BoE’s 2% target,” Bill Diviney, ABN-AMRO’s senior economist, wrote on 5 December.

The Consumer Price Index (CPI) rose 10.7% in November 2022, retreating from a 41-year high of 11.1% in October. Rising food prices and housing and household service costs, primarily from electricity, gas and other fuels, remained major contributors to the UK inflation rate, particularly the CPIH reading (including housing costs) in November.NFLATION CHART

Analysts believed inflation has peaked at 11% and will begin to slow in 2023. However, the government’s plan to reduce energy bill subsidies beginning in April could hasten the pace of price rises once more.

In November the Bank of England (BoE) lowered its UK inflation forecast to 10.9% for Q4 2022, from 13.1% in its previous estimates. Inflation was expected to drop sharply to 5.2% in Q4 2023 and to 1.4% in Q4 2024, with zero inflation in Q4 2025.

The British Chamber of Commerce (BCC) on 12 December projected inflation to ease to 5% in the fourth quarter of 2023 and drop to below the Bank of England’s target to 1.5% within a year in the fourth quarter of 2024.

ING forecast on 22 December that inflation in the UK could drop to 7.1% in 2023, from an estimated 9.1% in 2022 and finally fall below the BoE’s target to 1.9% in 2025. Meanwhile, ABN-Amro on 12 December forecast UK inflation to slow to 6.6% in 2023, from 9% in 2022.

The Bank of England raised interest rates nine times between December 2021 and December 2022 to combat inflation, bringing the benchmark to 3.5% in December. The UK central bank is expected to keep raising rates further, but at a slower pace.

The BoE projected that the bank rate could rise to 5.2% in the fourth quarter of 2023, before dropping to 4.7% in 2024 and 4.4% in 2025. 

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On 5 December, ABN-Amro forecast that the BoE could have two 25bp cuts in the fourth quarter of 2023, which will likely be followed by further cuts in 2024. The series of rate cuts could take the Bank Rate back to neutral levels of 2% by 2024.

However, by hiking interest rates, the UK central bank is performing a balancing act, as higher rates will raise short-term inflation and slow the economy. 

Sunak’s economic policy

On 25 October, Sunak took over from Truss as the UK’s new prime minister, after her highly ambitious growth plans rattled global markets and sent the pound to a new 37-year low – with government bond yields rocketing.

The Bank of England had to intervene with a £65bn ($72.77bn) programme to settle the gilt market, Reuters reported.

The growth plan, announced on 23 September, aimed to jump start the UK economy through tax cuts and other measures funded by government borrowing. It included capping the average household energy bill at £2,500 a year and scrapping a planned rise in corporation taxation to 25%.

It is now up to Sunak to navigate the UK out of the economic headwinds. On 17 November, Chancellor Jeremy Hunt unveiled a growth plan that combines tax increases and spending cuts to balance the budget.

The plan includes reducing the tax threshold at which the 45p rate becomes payable from £150,000 to £125,140 and raising windfall tax for energy businesses from 25% to 35%. The new Energy Profits Levy will be effective from 1 January 2023 to March 2028.

The UK Government would stick to its plan to spend £55bn this winter to assist households and businesses with energy bills, Hunt said in the speech. The government agreed to continue the Energy Price Guarantee for a further 12 months but increase the level to £3,000 per year for the average household from an initial plan to cap the annual energy bill at £2,500.

There are also two new fiscal rules: underlying debt as a percentage of GDP must be reduced within five years, and public sector borrowing must be less than 3% of GDP.

ABN-Amro’s Diviney said:

For now, though the new government has rescued the UK economy from a potential crisis, it is unable to prevent the unfolding recession.
“Tighter monetary policy will be compounded over the coming years by increasingly tight fiscal policy. Although the government is stepping in to shield households from the worst of the energy crisis, from next April it will be raising significantly higher taxes on both businesses and workers, with the overall tax burden on the economy expected to reach the highest since the end of World War Two.”

UK economy forecasts look gloomy

With expected double-digit inflation due to the rise in energy prices and consecutive interest rate hikes, what are the latest UK recession predictions?

The BoE forecast the UK to enter recession in 2022, starting from the fourth quarter and lasting for at least two years. It projects the UK economy will grow by 0.2% by the end of Q4 2022. The economy is expected to contract by 1.9% in the fourth quarter of 2023, then slow to -0.1% in the fourth quarter of 2024 before rebounding, according to the November policy report.

In its UK economy forecast for 2023 as of 22 December, ING expected GDP to contract -1.3%. The country’s economy was projected rebound to 1% in 2024 and 1.6% in 2025.

In its 12 December UK’s economy forecast, ABN-Amro projected GDP to contract by -1.3% from 4.3% growth in 2022. The Dutch lender expected the country’s economy to recover to 1% growth in 2024.

Scotia Bank projected the UK economy to contract -0.9% in 2023, from an estimated 4.3% in 2022, as of 8 December. The economy was forecast to rebound to 1.2% in 2024.

The bottom line

Most analysts cited in this article predict that the UK’s inflation will ease in 2023 as a result of the recession, before returning to the BoE’s target of 2% by 2024.

Bear in mind that analysts’ predictions can be wrong. You should always conduct your own research before trading, looking at the latest news, technical and fundamental analysis and a wide range of analyst commentary. Past performance does not guarantee future returns. And never trade money that you cannot afford to lose. 

FAQs

When was the last recession in the UK?

The last UK recession was in 2008 during the global financial crisis. At that time, the UK’s GDP dropped for five consecutive quarters.

Will there be a recession in 2023 in the UK?

Analysts and economists forecast that the UK may enter negative economic growth in 2023. The BoE forecast the UK would enter recession in the fourth quarter of this year due to temporary internal and external headwinds. Meanwhile, ING forecast the UK economy to contract -1% and -1.7% in the first and second quarters of 2023, hence entering a technical recession. The bank expected UK to continue negative growth throughout 2023. Remember, analysts’ predictions can be wrong.

How long do recessions last?

A technical term for a recession is two consecutive quarters of decline in GDP. According to the International Monetary Fund (IMF) a recession typically lasts about a year and results in a significant fall in economic output.

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The difference between trading assets and CFDs
The main difference between CFD trading and trading assets, such as commodities and stocks, is that you don’t own the underlying asset when you trade on a CFD.
You can still benefit if the market moves in your favour, or make a loss if it moves against you. However, with traditional trading you enter a contract to exchange the legal ownership of the individual shares or the commodities for money, and you own this until you sell it again.
CFDs are leveraged products, which means that you only need to deposit a percentage of the full value of the CFD trade in order to open a position. But with traditional trading, you buy the assets for the full amount. In the UK, there is no stamp duty on CFD trading, but there is when you buy stocks, for example.
CFDs attract overnight costs to hold the trades (unless you use 1-1 leverage), which makes them more suited to short-term trading opportunities. Stocks and commodities are more normally bought and held for longer. You might also pay a broker commission or fees when buying and selling assets direct and you’d need somewhere to store them safely.
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