What’s in store for the UK economy in 2023?

The UK economy is facing a lot of problems right now. What are the main challenges and how will these affect the economy in the year ahead?

Calculator showing 2023 and a pen on a wooden surface
(Image credit: © Getty images)

The pandemic might be all but over, but its spectre continued to haunt the UK economy in a tangible way in 2022, and it now looks as if the economy is heading for a recession.

The spectacular collapse of Tory politics and economic policy also hasn’t helped. Political stability could have provided the support so desperately needed.

High inflation, a squeeze on corporate profits and the ensuing cost of living crisis are a direct result of the imbalance caused by the lockdowns.

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Russia’s war on Ukraine further only added to inflation as imports of Russian gas were reduced leading to a surge in energy prices. Food prices also rose as Ukraine’s exports were impacted. Along with Russia, it supplies half the world’s exports of vegetable oils.

As prices of everything from energy to tomatoes have surged, the Bank of England has rushed to increase interest rates. They now sit at the highest level in 14 years (this is great news for savers).

These developments have hit the UK economy hard. While UK GDP grew by 0.5% in October from the month before, it shrunk by 0.3% in the three months to October, compared to the May-July period.

The challenges facing the UK economy in 2023

There’s no sugarcoating it, the next year is predicted to be another tough one for the UK economy.

Inflation is likely to remain high, and it’s unlikely to return to the Bank of England’s (BoE) target rate of 2% anytime soon.

Sanjay Raja, Chief UK Economist at Deutsche Bank says, “We see CPI landing around 6% by the end of next year.”. For the full year 2023, the bank’s analysts expect CPI inflation to average 8.1%.

With inflation high, interest rates will stay firm too. As Nomura UK Chief Economist, George Buckley and his team said in a recent report, BoE policy rates will rise “to a peak of 4.50% by end-Q1 2023”. This is another percentage point increase from the current rate of 3.5%. The bank also expects it to stay at these levels until early 2024.

As both inflation and interest rates stay high, the economy is expected to spiral into a recession, if we are not in one already.

Nomura thinks “the UK entered recession in Q3 2022 and [we] see growth contracting until the end of 2023 (by just over 2%).”

Deutsche Bank also believes that a recession is coming, though it expects a more modest decline in GDP of 0.9% next year.

How does the UK economy compare to other nations?

The UK isn’t the only economy heading for a recession next year if that’s some comfort.

Other nations, such as Germany and Italy are also expected to see a contraction in economic activity next year. However, Goldman Sachs’ projections estimate that the UK economy will contract by 1.2% in 2023, double the decline expected for Germany and far worse than Italy’s expected contraction of 0.1%.

The only large economy that’s expected to print a worse performance is Russia.

On the other hand, Goldman reckons the US and Japan are expected to grow by 1% and 1.3%, respectively.

It’s a matter of individual forecasts though. Nomura forecast recessions for the US, big EU economies of Germany, France, Italy and Spain along with the UK for 2023. In fact, it sees the euro area shrinking by 1.4%, similar to the 1.5% decline expected for the UK.

What do these projections mean for you?

Whichever way we look at it though, for people like you and me, none of this sounds like good news. Household budgets will get tighter as prices continue to rise and the cost of credit remains high.

However, the unemployment rate remains low at 3.7%, close to the lowest level in five decades.

What’s more, businesses are still desperate for staff and this is resulting in labour market tightness, which is driving earnings higher. Deutsche Bank says “the UK’s labour supply shock has been nothing short of historic”.

It adds “In the last 12 labour market reports, AWE Regular Pay has outshot consensus expectations 10 times.”, where AWE refers to average weekly earnings. Further, wages have seen “the strongest growth outside of the coronavirus (COVID-19) pandemic period” according to the Office of National Statistics (ONS).

So, despite all indications to the contrary, it would appear that if you are looking for a new job, the time to go job hunting is now.

Still, according to the Office of Budget Responsibility (OBR), the unemployment rate is expected to rise in 2023, hitting 4.1% by the end of the year.

Analysts also believe that rising interest rates will put pressure on house prices. The OBR expects them to start falling modestly in 2023 and faster in 2024, after a 10.7% increase this year, although if your earnings are rising, this could be a good time to buy a house.

What’s the long-term outlook for the UK economy?

The good news is that from 2024, the OBR expects things to get better. The government body is expecting GDP to rise consistently by over 1.1% between 2024 and 2027.

Moreover, according to Raja inflation too will decline to the BoE’s target level by “around late 2024 or early 2025”.

However, there are notes of caution too. As Buckley and his team point out “the measures announced by the Chancellor to tighten the public purse strings only really start to bite in 2025-26” and spillover beyond that too.

Further, Nomura expects the spectre of Brexit will also continue to play a big role in how the UK economy performs.

Nomura points to the sluggish post-Covid recovery in international trade for the UK compared to the G7, and foreign direct investment has also suffered. Less low-cost labour from Eastern Europe could also make it harder for businesses to grow and keep costs low.

Manika Premsingh

Manika Premsingh is a macroeconomist and a stock analyst. Her investment research and writing is published on Seeking Alpha and in the past on The Motley Fool. She has also extensively provided research on both the economy and the stock markets for companies in investment management, stock broking and investment banking.

She is also a public speaker, having shared her views on the economy at various international forums. She has also been quoted for her views on the economy over the years in leading international publications. 

Manika has a masters in economics and has done a certification programme in entrepreneurship, for which she received the Goldman Sachs 10,000 Women scholarship. Most recently she has completed a short course in sustainable development and is pursuing a certification in impact measurement & management for sustainable development goals.