Economic data during February have been better than expected, leading to greater optimism over the economic outlook for 2023. Despite this, GDP growth is still expected to be weak at best, and household budgets remain under severe pressure because of high inflation.

This Insight summarises recently published economic data and explores how they affect the outlook for the rest of 2023.

GDP weak during 2022

GDP was weak at the end of 2022, with Office for National Statistics data showing a monthly decline of 0.5% in December. Economic output was driven lower by falls in the use of hospitality, transport, and health services (such as GP appointments and operations), partly because of strikes.

For the whole of the fourth quarter (Q4) of 2022, GDP was unchanged compared with the previous quarter. GDP decreased by 0.2% in Q3 2022. This meant the UK economy has so far avoided falling into recession, commonly defined as two successive quarters of declining GDP. However, this near miss doesn’t hide the underlying weakness of the economy.

High inflation means consumers are more cautious in their spending, with businesses facing rising input costs. GDP during 2022 was stagnant overall, with GDP in December 2022 roughly the same (-0.1%) as a year before. Compared with its pre-pandemic level, GDP in December 2022 was 0.5% lower.

The chart shows the level of UK GDP from the start of 2017 to the end of 2022. GDP rose fairly steadily from 2017 to the start of the pandemic in early 2020. GDP fell sharply during the pandemic but recovered by late 2021 to what it was in February 2020. GDP has stagnated during 2022.
Source: ONS, monthly GDP data (up to Dec 2022)

Inflation seems to have already peaked

The inflation rate of consumer prices was 10.1% in January 2023, down from 10.5% in December. The annual inflation rate is defined as the change in prices compared with those in the same month the year before. The recent peak of 11.1% in October was a 41-year high.

The inflation rate is expected to fall during 2023. One reason behind the anticipated decline is that past price increases, such as the steep rise in household energy bills in 2022, will drop out of the year-on-year inflation rate.

There are also signs that some global price pressures are subsiding. Falling wholesale gas prices may cause energy bills to come down later in the year. In addition, the global supply chain pressures that were involved in driving up imported goods prices in 2021 and 2022 have eased.

In early February, the Bank of England forecast that the inflation rate would fall to around 4% by the end of 2023.

The chart shows the overall CPI inflation rate from the start of 2017 up until the end of 2025, including the Bank of England’s latest forecasts. The CPI climbs quickly from less than 1% in early 2021, reaching a peak of 11.1% in October 2022, before falling slightly before up to January 2023 (10.1%). The Bank of England forecasts the inflation to continue falling, to 3.9% in Q4 2023 and then below 2% in 2024 and 2025.
Sources: ONS monthly outturn data up to Jan 2023, then quarterly forecasts from Bank of England Monetary Policy Report, Feb 2023

The Bank has an inflation target of 2% and has been raising interest rates since December 2021 to lower the risk that inflation remains persistently above its target. Higher interest rates raise borrowing costs, lowering demand for goods and services in the economy. This in turn reduces pressure on firms to raise prices.

The Bank is keeping a close eye on inflation in services, which is considered more likely to persist than inflation in goods. This is because services are more dependent on domestic price pressures, such as labour costs.

Services inflation reached a 30-year high of 6.8% in December 2022 but fell to 6.0% in January 2023. How this indicator evolves over 2023 will help determine how much the overall inflation rate falls this year and how much further the Bank of England raises interest rates.

Signs of optimism ahead of the Spring Budget

In recent weeks, economic data releases have been more positive than expected:

The chart shows a measure of business activity, the purchasing managers’ index, since 2017. During 2022, the index measure for both the services and manufacturing sectors fell below 50, indicating contracting activity. In the latest month, February 2023, there were upward moves with the services measure now above 50 indicating expansion and manufacturing up to nearly 50.
Source: S&P Global / CIPS United Kingdom PMI, monthly data, Feb 2023 figures are flash estimates

The less gloomy figures have led economic forecasters to raise their expectations for economic growth in 2023. An improving outlook for the economy in 2023 does not, however, mean that all is suddenly well.

Inflation remains high. Average real (inflation-adjusted) wages are falling. Uncertainty abounds. For example, the path of the conflict in Ukraine remains unclear, with potential shocks to energy markets still possible. Even in more optimistic forecasts, GDP growth in 2023 is still expected to be close to 0%.

The Chancellor will deliver his Spring Budget on 15 March (look out for a background briefing from the Library). While the outlook for the short term has improved since his Autumn Statement, economic conditions and the state of the public finances remain difficult.

About the author: Daniel Harari is a researcher at the House of Commons Library, specialising in UK and international economies.

Image by bukhta79 at Adobe Stock

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