UK economy: A really hard winter and a slow recovery

The UK economy is currently in deep troubles during these days after the death of the Queen. The energy crisis and high inflation rates will most likely lead to a recession. Starting in the summer of 2023, there will be a slow recovery. I think that the recovery will be slower than some other forecasters think. Liz Truss, the new Prime Minister faces many challenges. As one of her first measures, she rather surprisingly introduced a cap on energy bills. This will be popular and should limit the burden on households and will tend to dampen inflation. However, a couple of open questions remain and despite that, many people are suffering and private consumption will contract.

In the second quarter of 2022, the UK economy already contracted by 0.1 percent. I think that we will see negative rates of around 0.5 percent until the first quarter of 2023. Overall, there will still be economic growth in 2022 on average (+2.9 percent), but stagnation on average in 2023. The recovery will start in the summer of 2023 and show up in higher annual growth in 2024 (+3.1 percent). Inflation will further increase and may even approach 14 percent in the winter when compared to the previous year. It will stay high in 2023, but I think that inflation will be reduced somewhat faster than others expect. Interest rate increases by the central bank will be fully effective in 2023, which means that they will reduce inflation but also dampen economic activity. By 2024, inflation will be back to around 2 percent. Currently, the bank rate is at 1.75 percent and will further increase this year to more than 3 percent. A first decrease might be conceivable in the fall of 2023.

Somewhat underestimated is currently that the depreciation of the pound will help UK exporters in 2023 and 2024 during the recovery. In the meantime, however, the negative effects of the depreciation become visible in higher import prices and inflation.

In the medium term, the UK economy faces the challenge to improve productivity growth. In the past decades, the United Kingdom has seen only meagre productivity growth rates. This will be one of the main challenge of the new government. In addition, one should not underestimate the possibility of an independent Scotland that may be associated with political tensions and high uncertainty.

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