A flow of key data over the past 10 days suggests that the UK economy is showing a level of resilience that was not in evidence just a few months ago.
Inflation has fallen more than expected and the labour market remained robust, according to the latest data, which has left many economists anticipating the end to further interest rate rises by the Bank of England and a milder recession than previously predicted.
With most measures of underlying inflation easing in January, the headline figure fell to 10.1 per cent last month. Services inflation, a better measure of domestically generated price pressures, fell more than expected, including a slowdown in price growth in labour-intensive industries, such as hotels and restaurants.
There are tentative signs that inflation “may not be as persistent and stubborn as some feared,” said James Smith, economist at the Resolution Foundation, a think-tank.
Those figures released last week “increase the likelihood of a milder recession,” said George Moran, economist at the bank Nomura. “Less inflationary pressure should boost real incomes, and also means less financial tightening is required from the Bank of England,” he added.
Markets are still pricing in a 0.25 percentage point interest rate rise when the Bank of England’s monetary policy committee meets on March 23 but expectations are growing that it could be the last.
Other official data published last week showed that the labour market remained resilient at the end of last year, adding more jobs than expected and the fall in real wages easing. Inactivity, which tracks people outside the workforce, also fell after rising for most of the past three years, a trend that had aggravated labour shortages and added to inflationary pressures.
“Whilst we still foresee a recession this year, we think that this is likely to be shorter and less pronounced than the Bank anticipates,” said Simon Harvey at Monex Europe. The uptick in labour force participation could result in output expanding faster than the central bank has forecast, he added.
Elsewhere, the economy is also showing unexpected signs of resilience. Analysts were surprised by data released on Friday showing a rebound in retail sales in January, up 0.5 per cent compared with a month earlier. GDP data published earlier this month showed that the economy managed to dodge a recession in the last quarter of 2022, with real household spending marginally expanding despite high inflation and rising borrowing costs.
“The economy is proving to be remarkably resilient to the dual drags of higher inflation and higher interest rates, and it certainly feels as though it isn’t as weak as most had feared,” said Ruth Gregory, deputy chief UK economist at Capital Economics.
She thinks that the government energy support packages have been “effective” and “that households and businesses have been spending the cash reserves they built up during the pandemic”.
The likelihood and depth of any recession depends on the choices made by Jeremy Hunt, the chancellor, in the upcoming Budget on March 15, not least whether he reverses plans to cut energy bill subsidies to households, which will see the cap for a household with typical usage rise by £500 to about £3,000 a year from April, Smith said.
“Putting in place that sort of measure would be an effective way to bring down inflation, help boost households and, in that way, minimise your chances of a recession,” Smith explained.
He added that the sharp fall in wholesale gas prices from their peak, although “not yet in the actual economic data”, was “incredibly good news” for the economic outlook. The price of European natural gas fell to an 18-month low last week.
Despite the encouraging data, the UK economy remains the only one in the G7 not to have recovered to pre-pandemic levels, while UK inflation remains higher than in the US or the eurozone. “The picture we are getting from UK data is clearly better than economists expected a couple of months ago, but far from positive,” Moran said.
Samy Chaar, chief economist at the bank Lombard Odier, said he did not see any change in the outlook for Britain relative to its peers. “We really expect the UK economy to continue to underperform its history” and other advanced countries, he said.
Economists have identified several factors dragging on growth which many attribute in part to Brexit. Business investment remains weak in comparison with historical trends and peers. UK exports have not rebounded as much as in other advanced economies from the hit of the pandemic. And, unlike in the eurozone, the labour force has yet to return to its pre-pandemic levels.
“We are expecting a relatively mild recession, while inflation worries should be largely behind us later this year, but some of the underlying weaknesses are still there,” said Yael Selfin, chief economist at the consultancy KPMG.
