Economic growth in the UK has defied expectations, exceeding the downbeat forecasts made at the start of 2023. So far this year, the UK economy has avoided entering a recession. There are a few reasons for this. The government’s energy-price guarantee has shielded households from the worst effects of higher wholesale energy prices, supporting consumer demand, while the savings people built up during the pandemic have supported consumer spending. We’ve also seen decent growth in wages because labour markets have been strong. And the prevalence of fixed-rate mortgages has delayed the effects of higher interest rates on people’s mortgages, disposable incomes and hence economic activity.

But avoiding a recession does not mean growth has been good. October’s consensus forecasts suggest that the UK economy will only expand by an upwardly revised 0.4% in 2023.

What’s more, previous interest-rate rises will drag on economic activity as mortgages are increasingly financed at higher rates. Indeed, recent business surveys suggest the UK has been flirting with recession in recent months as the increased cost of living and higher interest rates have taken their toll. The environment for global trade and manufacturing is also weighing on export activity, suggesting a third consecutive month of falling output in October.

Though the overall pace of decline looks modest, UK GDP is expected to only manage a full-year increase of 0.3% in 2024. If realised, this would make 2023 and 2024 the worst full-year growth outcomes since the global financial crisis in 2008/09, excluding the pandemic-driven downturn in 2020.

More positively, inflation has declined recently. But this is mostly down to a steep year-on-year decline in energy prices compared with last autumn’s steep increases and a moderation in food price inflation. In the near term, it’s a little concerning that the UK economy is generating strong wage growth and services-price inflation at a relatively low pace of growth.

This points to an economy operating with limited spare capacity – despite a recent rise, unemployment is still low by historic standards and there are a lot of job vacancies. The excess demand for labour versus supply is keeping upwards pressure on wages, which grew 7.8% year on year in the three months to August. While growth in real wages (i.e., after inflation) is a potential positive, anything that supports demand and leads to further price pressures may prompt the Bank of England to keep interest rates higher for longer to guard against the risk of a wage-price spiral.

Looking ahead

The UK economy has so far escaped the worst predictions for growth made at the start of 2023, but we expect growth to be lacklustre in the near term. While inflation should fall further in the coming months, strong wage and service-price growth points to stickiness in inflation above the Bank of England’s target. With the full impact of past monetary tightening and cost-of-living increases starting to hit home, lingering concerns about inflation might limit the extent to which policymakers are able to reduce interest rates to support economic activity.

Despite avoiding the worst expected outcomes, the UK economy still faces near-term stagflationary conditions – that is, a situation where high inflation combines with stagnant economic growth. Forecasts suggest the UK will have one of the lowest real growth rates, alongside one of the highest inflation rates, among the major advanced economies in both 2023 and 2024.

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