The impact of the war in Ukraine
Despite the recovery of the economy from the pandemic and the Government's move to a ‘Living with COVID’ plan, the impact of the war in Ukraine is expected to slow growth in the UK and other advanced economies.
Earlier this year, the UK economy had confidently grown beyond its pre-pandemic size and most sectors of the economy were growing. The UK labour market was running hot, with the unemployment rate dropping below 4% and the Bank of England starting to raise its base rate back to levels experienced before the pandemic.
Since then, the war has presented a significant shock to the global economy and is expected to impact the UK economy in three key ways:
- Higher commodity prices and the disruption of supplies
- Financial contagion
- Lower trade and investment flows
Of these, we expect higher commodity prices to have the biggest impact on the UK economy. So far, the economic impact from the financial contagion and trade and investment channels appears to be contained and relatively small.
UK growth outlook
The UK growth outlook has deteriorated. Our outlook is based on two scenarios with different assumptions on how our reliance on Russian crude oil and natural gas will be resolved, along with more detailed assumptions on military performance and the nature of economic sanctions.
- Contained conflict scenario: assumes there are no further sanctions imposed on Russia.
- Economic escalation scenario: assumes further sanctions are imposed on Russia, leading to a dramatic restriction of crude oil and natural gas imports into the EU.
Depending on the scenario, we expect UK GDP growth to average between 2.8% - 3.8% this year, compared to a previous consensus GDP growth of 4.5%. The main driver of our revision is slower household consumption which is, in turn, driven by higher commodity prices. Real earnings are already contracting in the UK and are expected to continue to do so until at least the end of this year, with lower income households being disproportionately impacted.
Projected change in household disposable income by household income quintile, from 2021/22 to 2022/23
Source: ONS, OBR, PwC analysis
UK inflation outlook
The Consumer Prices Index (CPI) surged to a three decade high of 6.2% in February, more than four percentage points above the Bank of England’s 2% target inflation rate. Around half of the contribution to the headline inflation was driven by fuel, food and electricity prices. In the next few months, households and businesses will need to brace for further price increases, as the war in Ukraine adds to existing inflationary pressures.
- Contained conflict scenario: the war in Ukraine adds an extra one percentage point to our average annual inflation projection
- Economic escalation scenario: UK inflation hits a 40 year high of around 11% in Q4 2022, with the energy price cap to increase by around 75%.
CPI inflation (year-on-year), 2020 Q1 to 2024 Q4
Sources: ONS, PwC analysis
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