Tough times ahead for the economy as inflation bites

GDP growth expected to more than halve this year, before slowing further in 2023.

GDP growth expected to more than halve this year, before slowing further in 2023.

  • GDP growth expected to more than halve this year, before slowing further in 2023
  • A sharper deterioration in the external environment coupled with a stronger fall in consumer spending could see the UK economy enter a mild recession next year
  • Latest developments could see the Bank of England adopt a more gradual uplift in interest rates than is currently priced in by the markets, with two further rises expected this year

As the invasion of Ukraine and renewed lockdowns in China put upward pressure on commodity prices and keep supply chains under strain, UK GDP growth is set to slow to 3.2% this year and is forecast to fall further to 0.7% in 2023, according to KPMG’s latest UK Economic Outlook report.

Just as the UK economy returned to its pre-pandemic size, new shocks hit the global economy. There are growing concerns that policy actions to combat inflation, if combined with further fallouts from geopolitical tensions, could bring about another recession.

Table 1: KPMG forecasts – main scenario

KPMG has also developed an alternative scenario to capture some of the downside risks. The forecast models how a sharper deterioration in the external environment causing a recession in some of the UK’s major trading partners, together with a stronger fall in domestic consumer spending, could see the UK economy enter a mild recession next year, with a 1.5% fall in GDP in the year between 2022 Q3 and 2023 Q3.

Yael Selfin, Chief Economist at KPMG UK, commented on the report: “We expect growing external headwinds and weakening domestic momentum to see economic growth slow significantly over the next year, with a significant risk of a mild recession.  

“Manufacturing and financial services look to be among the worst affected sectors in our downside scenario. Manufacturing could fall by 5.1% in 2023 and 2.8% in 2024 as the sector tends to be more export intensive, whereas financial services could also see significant losses from a downturn as it raises the potential for significant loan losses and write-offs, with output falling by 8.8% and 2.5% over the next two years.”

Outlook for household incomes, inflation and interest rates

Household budgets have come under pressure as the high and persistent level of inflation erodes consumers’ purchasing power. Although support measures announced by the government have helped to mitigate the expected impact of higher energy bills for the lowest income households, overall household incomes are expected to fall by 0.8% in real terms this year and 0.5% in 2023.

KPMG’s new forecast sees average inflation over 2022 revised to 8.1%, up from 7.9% in its previous report. The peak in UK inflation is likely to lag that in some of the other major economies. Due to regulated energy prices being revised in October, the full impact on UK inflation will likely only materialise in the autumn, with the outlook remaining highly dependent on the evolution of future wholesale gas prices. Inflation will then begin to normalise from 2023 Q2 onwards and return to the Bank of England’s 2% target in 2024 Q2.

The Bank of England has now raised interest rates at five consecutive policy meetings since December 2021, bringing Bank Rate to 1.25%. However, rates are only expected to reach 1.75% by the end of 2022, with a pause in the tightening cycle afterwards to prevent inflation running well below the 2% target in the medium term.

Yael Selfin, concludes: “We expect supply issues to gradually ease during the course of this year, although headwinds in the form of a potential deterioration in Russian energy supply or further lockdowns in China as a result of its zero Covid policy could worsen the outlook. Combined with the pressures on household budgets, the Monetary Policy Committee will have to weigh the risk of high inflation spilling into pay growth against the risk of a recession. Facing such a trade-off, we think it is likely that the doves on the Committee could swing the balance towards a more gradual uplift than is currently priced in by the markets.”



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Notes to Editors:

Assumptions underpinning the downside scenario:

The downside scenario captures a potential deterioration across three main headwinds facing the economy, with the main impacts falling on the fourth quarter of 2022. These include:

  • A potential US recession arising from a significant monetary tightening by the US Fed;
  • A potential Eurozone recession due to interruptions of gas supplies from Russia, as well as a significant additional shock to global wholesale gas and oil prices;
  • An ongoing and worsening squeeze on UK household incomes leading to a sharp decline in household consumption.

The recession modelled in the downside scenario involves a 1.5% fall in GDP in the year between 2022 Q3 and 2023 Q3. This is less severe than other recessions the UK experienced in the past, especially compared to the Great Recession, which saw a nearly 6% fall in GDP in the five quarters following Q1 2008. The UK economy is expected to contract by 1.1% next year in the downside scenario following 3% growth this year, with consumer spending falling by 1.9% in 2023. Given the weak outlook a more severe scenario is a distinct possibility, although a lower likelihood than the main scenario.

KPMG forecasts for growth of the main sectors in the main and downside scenario:

About the research

The forecasts were produced by the KPMG macroeconomics team using a suite of external and in-house models capturing the main inter-relationships in the UK economy. As with all forecasts, these are subject to considerable uncertainty and the outturn may differ significantly.

About KPMG

KPMG LLP, a UK limited liability partnership, operates from 22 offices across the UK with approximately 15,300 partners and staff.  The UK firm recorded a revenue of £2.43 billion in the year ended 30 September 2021. KPMG is a global organisation of independent professional services firms providing Audit, Legal, Tax and Advisory services. It operates in 145 countries and territories with more than 236,000 partners and employees working in member firms around the world. Each KPMG firm is a legally distinct and separate entity and describes itself as such. KPMG International Limited is a private English company limited by guarantee. KPMG International Limited and its related entities do not provide services to clients.