Starting the year in recession does not bode well for greater stability in U.K. markets or the U.K. parliament.
The past year was one of significant turnover for the United Kingdom. Queen Elizabeth II passed away after 70 years of leadership; meanwhile, turnover at 10 Downing Street caught many observers and officeholders by surprise. We hope that the year ahead will bring greater stability of leadership, as it will be needed to deal with a troubled economy.
Under the best of circumstances, the U.K. economy was facing an uphill climb this year. The wounds of Brexit had not healed; the nation's involvement in global trade has been significantly curtailed since formal separation from the European Union. Delays of shipments have become the norm, and foreign investment into the U.K. is holding below its pre-Brexit rates. The land border between Northern Ireland and the Republic of Ireland remains a contentious line.
Brexit has also weighed on the U.K. labor market. The labor force ended a 25-year run of growth in 2020 as immigrants took the dual uncertainties of Brexit and pandemic lockdowns as their cue to return to their home countries. The workers who remain are enjoying an historically low unemployment rate, which is positioned to rise modestly as the economy contracts.
"On balance, we expect the U.K. to start this year in the midst of a recession."
Conditions for the U.K. became even more complex as the nation dealt with the global shock of energy prices. While the nation has a diverse array of energy production and generation resources, its limited storage capacity for natural gas makes the economy vulnerable to higher prices. In addition, nearly half the U.K.'s food supply is imported, leaving the nation exposed to high costs in this area.
Prior to the reforms that led to her administration's downfall, former Prime Minister Liz Truss passed a package of support measures to help the nation work through its cost of living crisis. The Truss plan placed a cap on energy bills of £2,500 per year. With this reform, the risk of a massive inflationary shock subsided. However, incoming Chancellor Jeremy Hunt has pledged to review this package in spring of 2023; the relief may prove short-lived. Truss also set a plan in place to expand oil and gas exploration, a necessary bridge as the nation builds toward greater and more sustainable clean energy production.
Between food and energy, much of the nation's inflation has come from higher import costs, which were exacerbated by the weakness of the pound. The sterling fell to a record low in September, on the back of market and political volatility.
"Under the best of circumstances, the U.K. economy was facing an uphill climb this year."
The Bank of England was the first major central bank to start rate hikes in late 2021, moving to larger increments of 50 basis points in summer 2022. We expect this cycle is near its end. The economy is undoubtedly cooling, and our forecast anticipates that a downturn is imminent. That said, we do not expect the recession will bring about rapid rate cuts. Policymakers are sensitive to excessive accommodation and stimulus.
New Prime Minister Rishi Sunak has certainly learned from his predecessor's missteps. In his past service as Chancellor and his earlier candidacy for PM, Sunak showed a preference for austerity and smaller government. His nomination helped to calm tense bond markets, and his policies are likely to give markets greater confidence in the nation's fiscal stability.
On balance, we expect the U.K. to start this year in the midst of a recession. However, we view this interval as a cyclical adjustment to higher costs and scarce labor. We see no reason to expect a severe downturn. On the other hand, we see no reason for optimism about a booming recovery, nor expectation of easy relief to the nation's challenges. Britons have often taken pride in their stiff upper lips, enduring times of burden. Such resiliency will be needed in the years ahead.
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