Sunday, January 01, 2023
Mild recession and falling inflation - barring accidents
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission.

Consensus is rarer these days than it used to be, now that we argue about everything, but it can be useful. Consensus forecasts for the economy enable us to see what the average expectation is for the year ahead, the wisdom of the economic crowd, if you like. They also allow us to look for areas where it might be useful to aim off that average expectation.

For some years the Treasury has performed the useful service of compiling a monthly set of tables of independent forecasters’ predictions. I think it arose from the time when it was responsible for the government’s official forecast and was criticised for ignoring what other forecasters were saying.

It is invaluable to me because I use it for compiling my annual forecasting league table, which I shall do in a couple of weeks. It also allows us to see what forecasters – and more than 30 are included in the survey - expect.

The latest compilation published a couple of weeks ago showed an average expectation for gross domestic product in 2023 for a fall of 0.7 per cent, a recession, but quite a mild one. Around that there is a range, with the gloomiest new forecast (made within the past three months) a fall of 2 per cent, and the most optimistic a rise of 0.7 per cent.

A year ago, nobody expected a recession in 2023 but a continued, if modest, post-Covid recovery of roughly 2 per cent growth. There is a similar pattern to inflation forecasts. Everybody is convinced that inflation, having topped 11 per cent recently, will fall. But the extent of that fall, to an average of 5 per cent by the final quarter of this year, with a new forecast range of 2.2 to 7.4 per cent, shows that uncertainty about the inflation outlook remains.

Early in 2022, the expectation was that there would be brief inflation peak last spring, after which it would fall rapidly. The cost-of-living crisis, which is the main factor driving the economy into recession, would have eased months ago, instead of which it intensified.

What else can I tell you about what forecasters are expecting? Government borrowing, the budget deficit, is expected to remain every high, with an average forecast of £166.9 billion for this year, 2022-23, followed by £133 billion in 2023-24. For comparison, the figure for 2021-22 was £125.4 billion. This was supposed to be a time of repair for the public finances, but they remain fragile.

The current account deficit, representing the UK’s external transactions, is put at £125 billion for this year, after £133 billion in 2022, so plenty or red ink there too. I should also mention the unemployment rate, which is a very low 3.7 per cent, having been down to 3.5 per cent, but is expected to rise to about 4.5 per cent by the end of the year.

These consensus forecasts, as I say, can be very useful and tell of a mild recession, a fall in inflation but to some way above the official 2 per cent target, big budget deficits and the UK’s external vulnerability because of a large current account deficit. I think you could describe the outlook as mixed; not terrible but not great either.

One thing we have learned over the past few years, however, is to expect shocks and surprises. Shocks are generally bad, and I sometimes describe the big ones we have had – the global financial crisis, Brexit and the Trump trade wars, the pandemic and the Russian invasion of Ukraine – as the four economic horsemen of the apocalypse.

There is no shortage of contenders for a fifth horseman, or even a sixth. Within government there is concern about an escalation of the war in Ukraine by Russia, including the use of tactical nuclear weapons, the thought of which send shivers down the spine. Any escalation could prolong the energy shock.

An even bigger shock for the world economy, and by extension our own, would be if China, emboldened rather than deterred by Russia’s failures in Ukraine, decided to invade Taiwan. Senior officials within government are fully aware of the economic threat that this would pose to the UK, recreating many of the supply chain difficulties associated with the pandemic.

A more direct worry is the progress of Covid in China, now that the zero Covid policy has been abandoned. We have tended to look at China’s Covid struggles through the prism of its leadership’s incompetence, and the U-turn on lockdowns in response to widespread protests. But, just as in 2020, rampant Covid in China poses a threat to the rest of the world, which is why many countries are requiring Chinese visitors to take tests. The last thing we want this year is another leg to the pandemic.

There are also domestic threats to the economy. The Bank of England is watching the coming pay round very closely. Indications that private sector pay settlements are pushing significantly higher could make it take a more aggressive approach to raising interest rates. That could also lead to a larger fall in house prices than currently seems likely, the wealth and confidence effects of which could hit spending hard.

What about pleasant surprises? The cost-of-living crisis has been running for many months and yet the economy has so far slowed rather than collapsed. The 0.3 per cent drop in GDP in the third quarter was gloomily reported but it was a mere pinprick compared with some of the plunges we saw during the pandemic.

Figures suggest we have not yet seen the consumers digging into the savings they built up during the pandemic (not everybody did of course) though on a il-advised visit to one of the southeast’s biggest shopping centres between Christmas and New Year people appeared to be spending as if there was no tomorrow, judging by the crowds and queues. Maybe this was the last hurrah before a January slump but there did not seem to be any shortage of money to spend, or credit cards to be brandished.

Another pleasant surprise would be if energy prices continue to ease back. European gas prices have in recent days been trading at levels similar to those prevailing before the Russian invasion and at only about quarter of their peak last August. Lower oil prices are also feeding through to price falls on forecourts. They have not fallen as fast as the motoring lobby would like, and I do not think we have ever seen greater variation in prices, but last week I found myself paying for petrol – yes, I know I should have an electric car – at prices last seen in the summer of 2021. This was not in the southeast. As noted above, it is too soon to say that the energy shock is over, though recent developments have been encouraging. If it is, one of the biggest drags on the economy would be removed.

One thing is certain. There will be shocks and surprises. We have to hope that the shocks are containable and the surprises pleasant ones.