Economic update: Inflation starts to fall but so does growth

The Chancellor’s November Autumn Statement was accompanied by official forecasts painting a gloomy picture of the economy over the medium term. Economic data released in recent weeks seems not to have brought better news.

This Insight looks at economic developments in November and December 2022 and the outlook for the coming months.

Inflation recedes but interest rates keep rising

Inflation in the UK eased slightly to 10.7% in November, down from 11.1% in October as measured by the Consumer Prices Index (CPI). As the chart below shows, this was largely because transport costs (mainly fuel) didn’t rise as fast as in previous months.

Most economists, including those at the Bank of England, think inflation has now peaked and will continue to fall over the first quarter of next year.

However, by historical standards inflation is still very high, and well above the Bank of England’s target of 2%. The Bank’s Monetary Policy Committee  therefore raised the Bank’s interest rate on 15 December for the ninth meeting in a row, taking it to 3.5%. Further rate rises are expected in the coming months.

In theory, higher interest rates work to lower inflation by raising the cost of borrowing. In turn, as people and businesses have less money to spend on other things and more incentives to save, there is less demand for goods and services.

Effects of recession appear

Office for National Statistics (ONS) figures published in November had already shown that the UK’s economy shrank in July to September. Further evidence started to appear in December. Although the economy grew by 0.5% in October compared to the previous month, this is largely because output was unusually low in September because of the extra bank holiday for the Queen’s funeral. The size of the economy is typically measured by GDP.

The economy shrank by 0.3% between August and October compared with May to July. As the chart below shows, it is barely any larger now than it was just before the Covid-19 pandemic.

The Office for Budget Responsibility’s forecasts expect the economy to continue to shrink for over a year, returning to growth in the fourth quarter of 2023. The Confederation of British Industry agreed with this in its most recent economic forecast, also forecasting that business investment and consumer spending would still be below their pre-pandemic levels by the end of 2024.

Analysis by the Financial Times shows that household spending has fallen more in the UK since the start of the pandemic than anywhere else in the G7, and indeed more than in almost any other developed economy.

Spending has not yet recovered to its pre-pandemic level. The latest figures from the ONS show that retail sales volumes in November were about 6% lower than they were a year ago, and are still slightly lower than at the start of the pandemic.

House prices have continued to rise in the official figures (the most recent data covers October 2022). However, early indications from lender Nationwide suggest that prices are beginning to fall.

Pay continues to lag behind inflation

Unemployment remains low, with the unemployment rate in August to October 2022 lower than pre-pandemic levels at 3.7%. Vacancies also remain high, although they are beginning to decrease.

These factors, along with high inflation, are driving growth in wages. Average earnings grew by 6.1% in August to October compared to the previous year, the highest growth in regular pay since 2000 (other than during the pandemic).

However, this growth is not keeping pace with CPI inflation – in real terms, wages fell by 3.9% over the same period. There was also a large difference between public and private sector pay, with growth of 6.7% (before inflation) for the private sector, but only 2.7% for the public sector.

During the pandemic, many people became “economically inactive” (not in work and not looking for work). As the chart below shows, there was a fall in economic inactivity in August to October, particularly among older people, although inactivity overall remains high. This could suggest that people who had previously retired are returning to the workforce, but it’s too soon to know for sure.

Analysis in the Guardian suggests this may mean pay growth is reaching its peak. This is because more people re-entering the workforce while vacancies are falling can reduce pressures to increase wages.

Further reading

• House of Commons Library, Rising cost of living in the UK
• House of Commons Library, Autumn Statement 2022: A summary

About the author: Philip Brien is a researcher at the House of Commons Library, specialising in spending

Photo by Nick Pampoukidis on Unsplash