Household income will come under pressure as tough recession dominates in 2023

2023 is expected to be an exceptionally difficult year for the UK economy. The country is almost certainly already in a year-long recession, one that will probably prove deeper than that experienced in the early 1990s.

The pressure on household real income will intensify as rising interest rates add to rising inflation.

According to RSM UK economist Thomas Pugh, the government’s austerity measures are not believed to hurt growth in the short term.

“Most of the pain has been delayed till after the next general election. But they won’t help the economy much even in the short term,” Pugh said.

Not all recessions are created equal

Not all recessions are created equal, however. Pugh expects GDP to decline by about 2.5 per cent.

“It will be slightly smaller than the recession of the 1990s and much smaller than the global financial crisis,” he insisted.

Pugh also forecasts that the unemployment rate will increase from 3.6 percent to nearly 5 percent by the end of 2023, leaving about 200,000 people out of a job.

Looking for good news? Inflation will fall by 2023.

The bad news is that it will probably average around 7.5 percent over the next full year.

High inflation and a tight labor market will force the Bank of England (BoE) to raise interest rates from 3 percent currently to around 4.5 percent early next year, Pugh said. ,

Persistent decline in real income

Households’ disposable income has been hit by a cost-of-living crunch, which has seen inflation jump from 0.5 percent in early 2021 to 10.1 percent in September 2022 due to a sharp rise in food and energy prices.

Pugh said the government’s Energy Price Guarantee (EPG) had shielded homes and businesses from the worst of the energy crisis.

But he said utility prices would rise by a further 20 per cent in April 2023, when the government’s Energy Price Guarantee will increase from £2,500 to £3,000 for an average annual utility bill.

“As if that wasn’t enough, rising mortgage rates will further reduce households’ disposable income,” Pugh continued.

Mortgage rates have moved well beyond the base rate as banks anticipate higher interest rates, meaning anyone with a mortgage over the next few months will see part of their income spent on rising mortgage interest.

Pugh rolled out two more years today for the average borrower on a two-year fixed-rate mortgage with a higher than 75 percent LTV ratio, with a proportion of their income being absorbed by monthly repayments from 22 percent to nearly 34 percent.

“What’s more, a loose labor market, as companies reduce hiring and even begin to cut workforce, will result in modest wage growth falling to more ‘normal’ levels,” They said.

“Throw in higher taxes of a potential 1 percent of GDP and a reduction in public sector salaries in real terms, and the 2023 outlook is bleak for household real disposable income,” Pugh said.

Overall, they expect the RHDI to decrease by 2.5 percent in 2023. This would be the biggest drop on record.

Consumers are believed to have considerable levels of savings on average, equivalent to about 10 percent of GDP.

“But with consumer confidence at record levels, we’re not expecting them to make much of a dent in these savings,” Pugh said.

Therefore, consumers have less money to spend and are less willing to spend it. This would inevitably mean a sharp reduction in consumer spending, especially on discretionary items such as hospitality and retail goods.

“We are expecting a 2 per cent drop in overall consumer spending next year,” Pugh said.

A rise in interest rates and a slump in demand will also weigh down business investment which is still about 8 per cent below its previous level, he continued.

“This is primarily driven by a decline in investment in offices and transport equipment, as demand for office space and travel has not fully recovered as many people continue to work remotely.”

Inflation is slowing but still high

The recession will go some way to reducing domestic inflationary pressures. Some leading indicators are already pointing to easing of domestic price pressures.

Pugh said energy price inflation is about to ease decisively, with UK CPI inflation soon starting to fall from October’s 41-year high of 11.1 per cent.

Moreover, the current $80 level of Brent crude oil prices suggests that the contribution of motor fuel to the headline rate will be almost nil by March.

“The stabilization of food prices over the last six months also points to a sharp decline in food CPI inflation next year,” he added.

Meanwhile, a drop in shipping costs and an increase in stock levels at retailers suggest that prices of core items will soon be back up.

“Nevertheless, inflation will remain high for most of next year. We expect inflation to be around 7 percent in mid-2023, around 4 percent by the end of 2023, but below the BoE’s 2 percent target in the second half of 2024.” May come

However, there is a risk that inflation proves more stable than we thought, either because a tight labor market means wage growth falls more slowly than we expected or because companies are rebuilding margins.

Indeed, the Q4 edition of the RSM UK MMBI showed that middle market firms are getting better at passing on costs.

“That said, the recession and weak demand will make it difficult for middle-market firms to continue to sustain higher costs,” Pugh said.

With inflation remaining high through 2023, it will be difficult for firms to continue protecting their margins.

And given the recent challenges to hiring employees and the relatively short downturn, firms will have more incentive to hoard labor than in previous times of economic weakness, he continued.

The exceptionally tight labor market perhaps explains why, according to the MMBI this quarters, 41 percent of firms said they hired more employees in Q4, despite the grim economic outlook.

“Ultimately, we expect the level of vacancies to fall from near-record levels to below one million and the unemployment rate to peak at 5 percent by the end of next year, well below the peak of 8.5 percent .after the global financial crisis,” Pugh said.

If all this came from employed workers becoming unemployed, it would mean a loss of about 400,000 jobs.

“But we do expect some people who are currently inactive, who are not currently looking for work, to come back into the workforce because they want to boost their incomes,” he said.

This would likely raise the labor market participation rate and mean total job losses could be closer to 200,000.

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