1. What is the current state of the UK economy – are we in recession yet?

The typical definition of a recession is two consecutive quarters of negative growth. It had been touch-and-go, but we have just about avoided that so far, as a fall in output in Q3 was followed by zero growth in Q4. This is instead better characterised as ‘stagflation’. That said, we are not out of the woods yet. Inflation has fallen from its peak, but at 10.1% it is still painfully high, with pressures particularly stark for essentials such as food and energy.

Household incomes have risen, but not by enough to compensate fully for the soaring cost of living. The good, or at least better, news is that wholesale energy prices have fallen substantially. This will help to rein in price pressures in due course – and not just directly for utility prices, but also in other goods and services, given that energy is a key input. But the impact of what is the fastest cumulative tightening cycle since the Bank of England started targeting inflation in 1992, still stands to build. We expect three quarters of contractions in GDP this year. Nonetheless, the recession we anticipate is likely to be fairly mild, helped by the tight starting point for the labour market and the pool of excess savings built up by households and firms during Covid.

2. What are we looking out for in the Spring Budget?

At the time of the Autumn Statement, the Chancellor was facing a very challenging situation, having to restore market trust in the government’s commitment to fiscal responsibility at the same time as not crushing the economy through fiscal tightening at a time of a cost-of-living crisis. He has handled this very successfully so far and been aided by good fortune in the form of a mild winter. He has had to spend far less during the tax year so far than budgeted for at the time, to the tune of around £30bn. This makes the March 2023 Budget a much easier task.

That said, public debt and borrowing is historically still very high, so the room for manoeuvre remains limited. Still, the main decision is now whether to offer further support to households and firms, or whether to save up generosity for the next fiscal event, closer to the time of the next General Election. Politically, we think the temptation of maintaining the Energy Price Guarantee at £2,500 rather than lifting it to £3,000 as currently planned will be hard to resist, at least for Q2 this year. Indeed, press reports suggest an extension of the current limit is forthcoming. The cost would be a relatively modest £2.6bn or so, and it would have the advantage of lowering consumer price inflation a little earlier than otherwise. Related to this, there are also demands for prolonging support for energy bills of corporates. A further main question is whether the Chancellor will be willing to put more money on the table to resolve public-sector strikes. Some olive branch may be extended, but major concessions would run the risk of prolonging inflation by keeping demand firmer than otherwise.

Within the Conservative party, there is a lot of pressure on Mr Hunt to ease the tax burden ahead of the election. It is perhaps too early for major giveaways when the risk remains that energy prices could mount again and necessitate further support in some form over the next winter. At the same time, we suspect high-net-worth individuals may benefit from some incentives to boost pension savings, perhaps through rises in contribution ceilings. The Chancellor may argue that, coupled with Solvency II reforms that give more scope for pension savings to be invested in assets that might help boost the UK’s growth potential. This would be a positive move for individuals and economy-wide growth prospects alike.

3. Has the new Brexit agreement affected the economy or markets in any way?

Outside Northern Ireland, the direct economic effect of replacing the Northern Ireland Protocol by the Windsor Framework is likely to be fairly limited. After all, Northern Ireland is only a small share (2.2%) of UK GDP, and even a rapid expansion of trade with other parts of the UK through smoother borders will not move the aggregate needle much. So far, there is therefore little discernible impact. That said, the indirect effects could become far more material. Already, there are positive signals of greater cooperation in scientific research between the UK and the EU becoming possible again. The Memorandum of Understanding on regulatory cooperation in financial services, stalled with the NI Protocol negotiations, now looks likely to be signed at last. The hope is that this is a precursor to the EU granting ‘equivalence’ to UK financial services, granting domestic market access in certain areas, which would be a major step forward. And President Biden appears well disposed to seeing relations between the UK and the EU thawing. Eventually, the possibility of a free trade agreement with the US may be dangled again. That would be a far greater prize still, which would likely underpin sterling as well.


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