Will Britain really dodge a recession?

• Demand has been ‘unexpectedly’ resilient despite sky-high inflation 
• Growth will remain ‘subdued’ due to high inflation, even though it is set to drop
• IMF said interest rates may have to remain high for longer to keep inflation at bay

The International Monetary Fund no longer expects the UK to fall into recession this year, but the institution forecasts growth will nevertheless be ‘subdued’.

In an update to its forecasts on Tuesday, the IMF now sees the UK economy expanding by 0.4 per cent in 2023, rather than shrinking by 0.3 per cent as it expected in April.

Chancellor Jeremy Hunt hailed the ‘big upgrade’, which means the UK will not be the laggard of the G7 this year.

Why does the IMF think the UK will dodge a recession?

The IMF said the upgrade partly reflects the dramatic fall in natural gas prices since last summer, which are back to levels last seen before the war in Ukraine began early in 2022. 

It also said that demand from consumers and businesses has been ‘unexpectedly’ resilient despite sky-high inflation, helped in part by rising wages and higher Government spending.

‘Buoyed by resilient demand in the context of declining energy prices, the UK economy is expected to avoid a recession and maintain positive growth in 2023,’ the IMF said.

A surge in the price of wholesale gas has been a key driver in the cost-of-living crisis, helping push inflation into double digits. 

European wholesale gas prices have fallen back drastically from their summer peak, when they hit over $340 per megawatt hour, to below €30 per megawatt hour this week. 

This should start feeding through to lower energy bills for businesses and households this summer, easing a squeeze on their finances and allowing them to spend more to keep the economy moving. 

However, how fast that happens depends on energy suppliers who hedge by buying gas and electricity well ahead of when it is needed. 

Is the IMF alone in upgrading its outlook for the UK? 

The Bank of England did a similar U-turn recently, saying the UK would avoid a recession this year thanks to lower energy prices and a stronger than expected jobs market. 

The UK’s central bank latest forecast for 0.2 per cent growth in 2023 is actually lower than the IMF’s revised numbers.

Economists at EY have also supported the view that a recession is not imminent, forecasting Britain to instead record 0.2 per cent growth in 2023. 

Will the UK economy pick up strongly?

Even though the UK looks likely to dodge a recession, economists do not expect growth to accelerate in the coming months.

This is partly because inflation, though falling, remains well above the Bank of England’s target of 2 per cent.

The IMF said: ‘Economic activity has slowed significantly from last year and inflation remains stubbornly high following the severe terms-of-trade shock due to Russia’s war in Ukraine and, to some extent, labour supply scarring from the pandemic.

‘The outlook for growth, while improving somewhat in recent months, remains subdued.’

James Smith, developed markets economist at ING, also thinks we shouldn’t expect strong economic growth as high interest rates will continue to hamper households’ budgets and business investment.

‘A growing number of UK households will refinance their mortgages over coming quarters, while higher interest rates are a constraint on investment,’ he explained.

‘The UK also isn’t totally immune from the recent banking stresses in the US, which we think is likely to tip the American economy into recession later this year and will inevitably have some spill over to the global economic outlook.’

Figures released today show that growth in the UK’s private sector has slowed this month, with manufacturers reporting a drop in production but service firms reporting resilient demand.

The closely watched S&P Global/CIPS flash UK purchasing managers’ index showed a score of 53.9 in May, down from April’s 12-month high of 54.9.

While a reading above 50 indicates growth, economists said companies continued to hike prices in response to higher costs and were not particularly optimistic about the coming months. 

Dr John Glen, CIPS chief economist, said: ‘Uncertainty returned as businesses were worried about higher interest rates impacting on business investment and consumers about their household bills.

‘Regardless of the swings and roundabouts shown in the data, neither sector was particularly cheery about the next 12 months as the evident weaknesses in the UK economy remained obstacles to a clear pathway to full recovery.’

If the UK does avoid recession, will we be better off?

Britons have seen a dramatic increase in the cost of living over the last year, from higher energy and food bills to soaring mortgage rates.

UK consumer price inflation has been falling in recent months, but was still high at 10.1 per cent in March.

The Bank of England is expecting inflation to have dropped sharply to 8.4 per cent in April when the latest official figures are released tomorrow. 

But this means consumer prices are set to keep growing fast this year, albeit at a slower rate than in 2022. 

The IMF also expects UK inflation to fall to around 5 per cent by the end of the year and to return to the Bank’s target of 2 per cent by the middle of 2025 – six months later than its previous forecasts. 

But it cautioned against ‘premature celebrations’, warning there was a risk that high energy prices could be replaced by more persistent price and wage pressures that could lead to inflation to re-emerge or plateau ‘at an elevated rate’.

Moreover, food inflation remains close to record highs, according to data by market researchers at Kantar. 

Food prices rose at a rate of 17.2 per cent in the last month, only marginally down from 17.3 per cent in April, and still marking the third fastest rate of grocery inflation recorded since 2008. 

Kantar said such high food and drink prices added an extra £833 a year to the average shopper bills. 

UK food price inflation was among the highest across G7 economies in March, second only to Germany, according to figures by the Office for National Statistics. 

The ONS noted that the high rate of annual food price inflation was in contrast with the recent decline in global food commodity prices, which it said ‘likely reflected how there were lags before price shocks to filter through the supply chain’. 

Myron Jobson, senior personal finance analyst at Interactive Investor, said: ‘Tomorrow’s inflation figures are expecting to show that while price increases are cooling, they still remain uncomfortably high. 

‘Many of us will remain in budgeting mode as heightened costs continue to weigh on household budgets.’

With inflation remaining high, households are also likely to face higher interest rates for longer, which means higher mortgage payments. 

The IMF said the Bank of England may have to keep interest rates high for longer to keep inflation under control.