1. What is the current state of the UK economy in terms of growth and recession?
Economic activity has remained broadly steady for a year now. This may seem disappointing, but to have avoided recession and much higher unemployment at a time of soaring energy prices, is a remarkable outcome. Government support to cap the energy cost burden for households and firms has been crucial.
Now that the energy shock is abating, the impact of sharply higher interest rates is increasingly starting to bite. As households re-mortgage at much higher rates and firms cut back on investment given high financing costs, we expect this impact to intensify. We therefore see a shallow recession in the offing for the second half of 2023. As price pressures ease and incomes recover, giving scope for some interest rate cuts, a rebound in GDP looks likely during 2024.
2. What is the outlook for inflation and the Bank of England (BoE) Bank rate?
Inflation has fallen from its peak of 11.1% to 8.7%. That is, however, still far above the 2% target. This fall reflects energy prices (and government subsidies for utility bills). However, there are some more helpful signals.
The labour market seems to be turning, slowly, which could eventually curb wage growth. In a recession, profit margins could come under pressure too.
In addition, supply chain disruptions are now largely a thing of the past, while global wholesale food prices have fallen steeply too.
We see inflation at around 4% in Q4 2023 and falling further thereafter. The Monetary Policy Committee will probably err on the side of caution and hike the Bank rate once more, to 4.75%. We doubt it will want to go much beyond that and expect that lower inflation will allow it to start cutting rates again. But that may have to wait until early 2024.
3. Have the liquidity issues faced by banks such as Silicon Valley Bank (SVB) affected the global economy?
While it is still too early to assess the impact of the shockwaves from the failure of Silicon Valley Bank and other institutions over the past few months, various warning lights have been flashing amber.
A principal danger is that banks which are concerned about deposit flight will become more conservative in their lending policies, choking off credit supply to companies and households. This risk was underlined by the Fed’s recent Senior Loan Officer Opinion Survey, which reported a widespread tightening in bank lending standards over Q1. At this stage, the effects are impossible to calibrate with any degree of precision. However, more difficult credit conditions will almost certainly add to the squeeze on the American economy from higher interest rates. Moreover, although the US is set to remain the epicentre of the storm, the effects are likely to be felt elsewhere in the global economy as well.
4. What can we expect from the European Central Bank (ECB) or Federal Reserve?
For the US economy, we anticipate a mild recession over the second half of this year. The most interest-sensitive parts of the economy, such as housing investment, are already buckling under much higher rates, and consumers have now exhausted excess savings built up in the pandemic. A further contributing factor is the tightening in credit conditions; and the debt ceiling deal entails a squeeze on government spending.
Even though inflation is still elevated, we therefore see the Fed pausing its tightening cycle at the current level of 5.00-5.25%, before beginning to ease policy in Q4.
In the Euro area, a pause from the ECB is not yet on the cards, given its concerns over the inflation outlook. We expect two further 25bp hikes, taking the key Deposit rate to 3.75%. This is against an economic backdrop which we expect to be modestly better than the US, with the economy expected to grow over the course of this year, albeit at a relatively subdued pace.
5. What are the next dates in the diary that economists are monitoring?
With inflationary pressures easing, policy rates may be approaching their peaks. June 2023 is likely to be a pivotal month, with the Fed expected to join the handful of central banks (such as the Bank of Canada and the Bank of Korea) that have paused tightening already.
Although we may have to wait longer for the ECB and the BoE to do the same, their respective meetings on June 15 and June 22 will still be of interest. From the ECB we will receive updated economic projections which should provide guidance as to how many further hikes may be needed to tame inflation. For the BoE, we will watch how concerned the Monetary Policy Committee appears to be about the recent hot CPI inflation print that drove a sharp repricing in market interest rate expectations. (Another CPI release is due just before, on 19 June). We will also be monitoring political developments.
In the UK, as the Autumn Statement draws closer, we also expect more speculation on potential tax cuts ahead of the next general election. Similarly, in the US, focus will be on the 2024 presidential election, with candidates officially launching their election campaigns in the next few months.
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Opinions, interpretations and conclusions represent our judgement as of this date and are subject to change.