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Economic Outlook U.K. Q4 2023: High Rates Keep Growth Muted

Economic growth in the U.K. is set to remain muted well into 2024 under the lingering impact of high inflation and monetary policy rates that will turn increasingly restrictive in real terms as inflation abates. This fundamental view of the U.K. economy remains largely unchanged from our late June forecast.

Even so, we have revised our forecast for this year slightly upward, to 0.3% from zero, but downward for 2024 to 0.5% from 0.8% in our previous forecast, shifting some of the slowdown into next year. This is mainly due to some idiosyncrasy in the in the composition of growth in the second quarter of this year, which we expect to unwind over the next quarters. In particular, we think household consumption, which expanded strongly in Q2, will see a downward correction in the second half of this year, as the earlier one-off factors that were behind that expansion are no longer in play.

Headline inflation hardly eased in August and still stood at 6.7% (see chart 1). But it was the recent rise in global oil prices that prevented a greater drop, and this will not change the broader picture of gradually easing inflation. Indeed, although producer price inflation also saw a small uptick, it remains firmly in negative territory and, with the usual delay, should continue to support the downward trend in consumer price growth.

Some of the good news the Bank of England (BoE) had been waiting for materialized when both core and services inflation reduced markedly in August, although levels remain high. It was an important step in the right direction and the BoE did not raise rates further on Sept 21. Still, the bank will unlikely be put at ease until pay growth--still running at 7.8% in July--starts easing, too. It may still take a few months until the BoE feels more comfortable with a peak rate of 5.25%, before it could lower rates again from the second quarter in 2024.

Chart 1


In the meantime, the impact of tighter financing conditions is already being felt throughout the economy, but still has some way to go before it reaches its full effect. Higher mortgage costs are a case in point: As previously fixed-rate periods expire or are refinanced at significantly higher fixed rates, the mortgage burden will rise across the approximately 30% of U.K. households that have a mortgage. Households that rent their home are affected, too, as rental yields rise in line with the broader interest rate environment.

While the cost of borrowing, in real terms, becomes increasingly restrictive to growth (see chart 2), there are some mitigating factors. Real wage growth has just turned positive and will improve further in the coming months. And although weakening, the labor market should remain firm by historical standards.

Chart 2


Supported by forbearance measures, this should prevent widespread distressed selling of homes. Still, during the pandemic house-price boom, affordability--measured as the ratio of prices over household income--deteriorated to unsustainable levels, in our view, and is now due for a sustained downward correction (see “European Housing Markets: Sustained Correction Ahead,” published July 20, 2023, on RatingsDirect).

Although financial markets have remained relatively calm recently, this could change in the event of significant downward surprises at home or abroad relating, for example, to the labor market, the conflict in Ukraine, or the housing market. Already tight financing conditions could quickly become overly restrictive and depress economic performance materially more than we currently forecast. At the same time, household resilience could prove more robust, despite wage growth moderation, in which case we see an upside to our growth outlook for the U.K.

There are also both upside and downside risks to our forecast from a technical side. The Office for National Statistics will on Sept. 29 release significantly revised national accounts data. These are likely to change our forecast numbers, but are unlikely to affect our broader view of a U.K. economy that remains close to stagnation until mid-next year.

Table 1

U.K. Economic Forecasts
2021 2022 2023 2024 2025 2026
GDP 7.6 4.1 0.3 0.5 1.5 1.6
Household consumption 6.2 5.6 0.4 0.4 1.7 1.8
Government consumption 12.5 1.8 1.1 2.6 1.5 1.4
Fixed investment 6.1 8.6 0.6 -2.2 3.2 2.5
Exports 2.2 9.9 -3.3 2.8 3.6 3.1
Imports 6.2 13.3 -4.3 3.5 4.4 3.7
CPI inflation 2.6 9.1 7.5 2.5 2.0 2.0
CPI inflation (Q4) 4.9 10.7 4.5 2.3 2.0 2.0
Unemployment rate 4.5 3.7 4.3 4.7 4.4 4.2
10y government bond 0.70 2.30 4.10 4.00 3.40 3.30
Bank rate (EOP) 0.25 3.5 5.25 4.25 2.50 2.50
Exchange rate (USD per GBP) 1.38 1.23 1.24 1.27 1.36 1.38
Source: ONS, BoE, S&P Global Market Intelligence, S&P Global Ratings (forecasts).

This report does not constitute a rating action.

Senior Economist:Boris S Glass, London + 44 20 7176 8420;

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