UK set to close 2023 with inflation just below 5% and avoid a recession - but real pay back at 2006 levels

• The UK will avoid recession but is likely to contract in the third quarter this year. On an annual basis, the economy is expected to grow by around 0.5% in real GDP this year and next, which has been revised upwards from our earlier projections in the year. 

• London and Northern Ireland are set to grow the fastest, but growth will remain subdued across the remainder of the other regions.

• CPI inflation is expected to end the year at under 5%, meaning No. 10 will meet its target to halve inflation. However, inflation will remain above the Bank of England’s target both this year and next. 

• Real earnings are expected to be lower in 2023 on average than in 2006 as a result of high inflation combined with long-term productivity challenges.

On an annual basis the UK economy is expected to grow by around 0.5% in 2023 and 2024, and is likely to avoid recession, according to PwC’s UK Economic Outlook. This is an improvement over PwC’s April Economic Outlook prediction of 0.1% growth for 2023, although  economic activity is likely to contract in the third quarter this year. PwC’s UK economics team also expects No. 10 to hit its target to halve inflation by the end of the year.

Not out of the woods yet

Inflation is expected to end the year at around 4.6% -  higher than predicted last publication (3.5%) but comfortably below No. 10’s target of 5.4% for the fourth quarter of 2023. There will likely not be a linear decline in 2024 as current natural gas and peak futures prices are pointing to household energy prices rising in the new year, due to current geopolitical instability in the Middle East. A full return to a 2% inflation target is unlikely until 2025. 

UK CPI inflation peaked at 11.1% in October last year and is down to 6.7% on the latest data. At a high level, this brings the UK closer to peers (5.6% in France and 4.3% in Germany, 3.7% in the US). Most of the recent falls in inflation have been driven almost exclusively by lower energy inflation. Services inflation is likely to drop down to around 6% by end of year, albeit only gradually as wage growth continues to remain above historic norms. Core goods inflation is expected to steadily drop as supply chains are in a better state, cost pressures are less intense and demand is slowing.

Barret Kupelian, Chief Economist at PwC UK says:

“Ever since economies have re-opened from the pandemic, inflation has been front of mind for every single business leader and policymaker. As we approach 2024, there are some encouraging signs that it is finally subsiding. By the end of this year, we expect inflation to be less than half the 11% peak recorded last year, with No. 10 meeting its target to halve inflation. However, it will remain above the Bank of England’s 2% target for next year. So there is a long way to go before we can declare ‘Mission Accomplished’ on the inflation front.

“According to our estimates, the UK economy has felt around half of the impact of the Bank of England’s policy tightening. So in the coming few months we expect to see large swathes of the economy to adapt to the impact of tighter monetary policy. For example, homeowners looking to remortgage next year are likely to see average annual repayments increase by around £3,000 per year. The more encouraging news is that it is unlikely we will see additional Bank of England base interest rate rises, assuming no unexpected shocks to the economy.

“But if recent history is any guide, the road ahead is likely to be bumpy. We are already seeing financial markets reassess upwards their views on future European natural gas prices. Even though it is too early to say, this is likely to marginally push up the household energy price cap in the UK in 2024. We are certainly in a better position now compared to the beginning of the year, but we aren’t out of the woods just yet.”

Real earnings growth flat for nearly two decades

The labour market continues to run hot, with regular pay growing by 7.8% in cash terms in the three months to August 2023. However, the story is radically different once taking a longer term view and adjusting for inflation. Specifically, by the end of the year real earnings are expected to be around the same level as in 2006. This is equivalent to no net earnings growth for 17 years, with the average worker earning around £17,000 less (in 2022 prices) than if real earnings had grown at their historic rates.

London and Northern Ireland the growth leaders across the country 

PwC’s UK economics team expects economic growth to average around 0.5% this year and next. But there are regional differences in the economic outlook, with London (0.8% growth) and Northern Ireland (0.6%) set to lead the way for 2023, while the West Midlands (0.2%), East Midland (0.3%) and Scotland (0.3%) will lag behind.

Jake Finney, economist at PwC says:

“The UK is currently experiencing a counterbalance of both positive and negative factors, which  ultimately means that despite encouraging progress this year growth has virtually flatlined, with real GDP up just 0.4% since December 2022. The positive improvements seen in the easing of the global supply chain pressures and lower than expected household energy bills is offset by stubborn inflation levels, rate rises, and industrial action in key sectors, all of which are weighing on economic activity.

“The overall headline stagnation in growth does hide significant sector successes. Hospitality has bounced back, in particular in hotel, catering and recreation as employment challenges have eased and foreign tourists have returned through the summer months. In contrast, business services have slowed in real terms, contracting by 2.6%  from Q4 2022 to Q2 2023 and reflecting a return to normal after a booming 2021 and 2022.” 

Ends.