The UK is beginning 2023 on the brink of recession as households and businesses come under intense pressure from the cost of living crisis, with inflation at the highest rates since the early 1980s.
The Bank of England has said the country is on track for a prolonged recession, as households struggle to keep up with the soaring costs of food, energy and other basic essentials. Here are five charts for the UK’s economic prospects in 2023.
Britain entered 2022 with inflation at just over 5% as the aftershock of the Covid pandemic and supply chain problems took their toll. But Russia’s invasion of Ukraine drove up inflation even further, with energy costs for businesses and consumers rising to eye-watering levels, and inflation reaching a peak of just over 11% in October – the highest level since 1981.
Most economists expect inflation to fall back gradually later this year as the initial shock from Vladimir Putin’s invasion works its way through the system. Inflation is measured as the annual change in price for a basket of goods and services, meaning the impact of the war in Ukraine from February 2022 will drop out of the official figures.
However, falling rates of inflation don’t necessarily mean prices are coming down. Living costs are expected to remain far higher than pre-Covid levels, with energy bills likely to remain more than double historical levels even after taking account of the government’s energy price guarantee, keeping up the pressure on households and businesses.
Economic activity has slowed sharply in recent months as consumers tighten their belts in response to soaring living costs, while business investment has slumped amid concerns over the strength of the UK and global economy.
Britain remains the only G7 economy with gross domestic product (GDP) below its pre-pandemic level. The Bank of England expects the recession to last for at least the whole of 2023 and the first half of 2024, before only a gradual recovery thereafter.
Continuing high energy prices are expected to weigh on activity, while higher borrowing costs for businesses and households after sharp rate increases from the Bank of England will also act as a drag. Company bosses warn that business investment will remain weak, with added headwinds from Brexit red tape and additional costs for exporters.
The economic slump is expected to drive up unemployment, as weaker levels of consumer and business spending, alongside higher costs, lead employers to take tough decisions about appropriate staffing levels.
However, the forecasts for a sharp rise in joblessness come at a time when companies are struggling to find enough workers, while the public sector is gripped by strike action as the government refuses to budge on pay.
Unemployment is at the lowest level since the 1970s, largely as a result of rising economic inactivity – when working-age adults are neither in work or looking for a job – after rapid growth in early retirement and rates of long-term sickness.
The decline in workforce participation means Britain is on track to be the only advanced economy with employment still lower than pre-Covid levels at the start of 2023. Employers have responded by raising wages, with annual pay growth close to 6%. However, this remains significantly below double-digit inflation, meaning real-terms pay cuts for most people.
Pressure on household finances from soaring living costs has been exacerbated by a steady rise in mortgage interest rates, as the Bank of England ramps up borrowing costs in response to inflation more than five times its official 2% target rate.
The Bank ends the year with its base rate at 3.5%, up from just 0.25% at the start of 2022, after the most aggressive drive to raise rates for a generation. Financial markets anticipate interest rates will peak above 4%, although the central bank could halt rises at an earlier stage.
These higher costs will feed through into the property market as families come to remortgage on higher rates. After a period of booming house price growth, and with weaker economic activity and rising unemployment, economists forecast a sharp decline in house prices in 2023.
The Office for Budget Responsibility expects house prices to drop by 9% between the end of 2022 and third quarter of 2024, wiping out much of the increase seen since the Covid pandemic. However, prices will still remain unaffordable for many.
It comes after the property market was hit by turbulence from Liz Truss’s disastrous mini budget at the end of September, which led to a rapid increase in borrowing costs. Conditions have now settled, although mortgage rates remain significantly higher than in previous years.
Jeremy Hunt pushed to win back investor confidence in the government finances after the disaster of the Truss mini budget, using the autumn statement to set out tight settlements for spending and raising more money through tax.
However, public borrowing is on track for a significant increase this year as the government spends more on support for households and businesses struggling with their energy bills, while inflation pushes up debt interest costs.
The budget deficit – the shortfall between spending and income – is forecast to hit £177bn in the financial year to the end of March 2023, almost £40bn more than a year earlier, before then gradually falling over the next few years.
With attention shifting to the next general election as the Conservatives languish behind Labour in the polls, the government will face pressure to offer more support and tax breaks to soften the economic downturn.