The UK’s growth downgrade - a short-term slump, hiding longer-term issues

This article is by Matt Latham, a Consultant Economist at Bradshaw Advisory. You can email him here.

In their recently released January Economic outlook, the IMF downgraded the UK’s growth forecast for 2023 by 0.9 percentage points compared to their October outlook, predicting the country’s economy to shrink 0.6% over the course of the year. This would set the UK to see the worst performance of any advanced economy and even behind Russia.
Although the report does note that the world has been less severely hit by the curtailing of Russian gas exports than some expected, with supply from other parts of the world responding quickly to the crisis and with a relatively mild winter containing demand, the war in Ukraine’s inflationary impacts are still being felt. Increased price uncertainty, as well as increasing interest rates from the Bank of England are curtailing business and consumer expenditure across the UK. The IMF also point to the recent fiscal tightening announced in the Chancellor’s Autumn Statement as a key factor behind the UK’s downgraded forecast.

While this all sounds particularly gloomy, it is worth pointing out that the factors behind this downgrade are signs of a temporary downturn as opposed to a structural fault with the economy. Curtailed consumer spending and business investment in the face of price uncertainty and interest rate increases should not be a surprise to anyone. Not only that, but noted in the January outlook is the fact that net savings in the UK are in fact increasing. That is, spending decisions are not being put off indefinitely, they are more likely simply being put off until conditions return to something resembling normality, meaning a bounce-back at some point will be likely.

Figure 1: GDP reductions in previous recessions compared to current BoE/OBR forecasts 

This all chimes with much of the analysis put out at the time of the Autumn Statement, which noted that while a recession was likely, it was unlikely to be as severe as many that we’ve seen previously (see figure 1). The key factor here being that the biggest issue putting downward pressure on the UK’s economic performance is external (the war in Ukraine) and not a structural fault with the economy.

Now, enough of the optimism - why is the UK forecast to do worse than everywhere else?

While the key bit of downward pressure on the UK economy currently is not structural, there are some fundamental issues the country is facing. Since the UK’s exit from the EU, a mounting terms of trade crisis has significantly dampened its trading performance, with the current account deficit last year reaching some of its highest levels as a proportion of GDP ever seen. Fiscal pressures in the wake of covid-19 also raise real questions about the sustainability of government spending. 

Perhaps most worrying is the country’s poor productivity growth and general stagnation since the Global Financial Crisis of 2008. This is having dramatic impacts on living conditions across the country, with real weekly wages currently no higher than they were in the late 2010s and for many workers, real earnings have fallen. 

This growth conundrum is a puzzle no one has cracked yet and one which will likely survive the current cost of living crisis.

Figure 2: UK real GDP, pre-Global Financial Crisis trend vs the true growth path

Something we may also want to consider here is the accuracy of the IMF’s forecast. As a general rule forecasting economic variables anywhere over a few months in the future is a bit of a fool’s errand. Despite this, under a fair few circumstances, the IMF has done a reasonable job of tracking the UK’s performance. The only real divergence we have seen them make is in their inability to foresee the covid-19 pandemic and to slightly over-predict our ability to bounce back from it. Given that many of the world’s epidemiologists were unable to see the pandemic coming, expecting some economists to have predicted it would have been something of a tall order.

Figure 3: UK real GDP growth, IMF forecast vs. true value

Note: forecast figures are all taken from the Economic Outlooks released in January