London’s Economy Today – editorial – November 2022
UK economy likely heading into a recession
This month saw the outlook for the economy come into clearer focus. The Government announced the future of the Energy Price Guarantee (EPG) and the Bank of England and Office for Budget Responsibility (OBR) released official forecasts just as the Office for National Statistics (ONS) published Q3 UK GDP data. At the same time, despite projections that inflation would sharply decelerate from mid-2023, October saw inflation accelerate to its fastest pace since 1981.
The main headline from several of these developments is that the coming two years is set to see the tightest squeeze on real living standards in more than six decades, triggering a recession.
The OBR’s forecast anticipates inflation-adjusted household disposable incomes falling over 7% in the next two years. This is the worst reading since at least 1958, when comparable records began, as inflation remains high while wages lag behind and tax bills creep up. As a result, the OBR sees GDP falling into recession at the end of this year, contracting until autumn 2023, and only recovering in late 2024. While the Bank of England does not seem to project quite as crushing an income squeeze, monetary policymakers expect a much deeper recession in output. The Bank sees GDP falling constantly for an entire two years and remaining more than 2% below mid-2022 levels even by the end of 2025.
The Organisation for Economic Cooperation and Development also released projections this month, with the UK set for the worst growth prospects in 2023 of any G7 nation. Yet the recession they forecast is shallower than in either the Bank or the OBR’s projections (Figure 1).
In any case, the widely-projected recession has likely already begun, with the ONS release of Q3 UK GDP showing UK output contracting by 0.2%. Combined with previous revisions showing that UK output has not yet recovered from the pandemic, this means that UK economic activity may not reach late-2019 levels until 2025 – or even later. While this suggests that output faces a ‘lost’ half-decade or longer, the Resolution Foundation suggests that earnings face an even starker stagnant outlook. In their analysis of the Autumn Statement, the think tank finds that in 2027, real wages will only just manage to reach their pre-financial crisis levels in 2008 – 20 years of ‘lost’ wage growth.
Q3’s GDP figures also saw the UK experience the worst output performance among the G7 so far (with Japan yet to release Q3 data). The decline was driven by a drop in consumer spending as households contend with rapidly rising prices. While investment rose, this was mostly driven by government activity, with business investment falling.
In terms of what this means for London, there are signs that the capital may not be set for as much economic damage. Average incomes are higher, Londoners tend to devote less of their spending to energy, and business and household surveys suggest less pessimism in the capital. The latest ONS regional GDP data suggest that although London saw some of the worst damage of any UK region in 2020, it also staged the strongest regional recovery after the final lockdown in 2021 (Figure 2). This momentum should put London in a relatively stronger position than the wider UK economy.
Big package of fiscal tightening announced by the Chancellor
The OBR forecast was published alongside the Autumn Statement, which was delivered by the Chancellor of the Exchequer, Jeremy Hunt, on 17 November. In this he announced a large fiscal tightening package. The size of the consolidation is projected to be £55 billion in 2027-28 being met by both tax and spending measures. It should be noted that a significant amount of this fiscal tightening is currently scheduled to occur after the end of the 2024-25 tax year, with some commentators expressing doubt as to whether these will actually occur.
While benefits and the state pension will rise with the rate of inflation, most departmental budgets did not see any further funds provided beyond those promised in the 2021 Spending Review. In total by 2027-28 public spending cuts should amount to around £30 billion.
For taxation, an extension of and increase in the Energy Profit Levy and the imposition of an Electricity Generator Levy were announced along with a number of other revenue raising measures. These included the freezing of national insurance and income tax thresholds as well as the lowering of the additional rate threshold to £125,140, along with other personal and business tax changes. Taking account of all these measures, tax as a share of GDP is set to reach 37.5% in 2024-25 its highest level since the Second World War. Despite this, debt as a share of GDP is projected to only just come below 100% of GDP by the end of the forecast period.
In terms of Government borrowing, public sector net borrowing is expected to be 7.1% of GDP in 2022-23. Borrowing then eases back somewhat to 5.5% of GDP in 2023-24 and 3.2% of GDP in 2024-25, before gliding slightly unevenly to 2.4% of GDP by 2027-28. All of these figures represent sharp upward revisions from the March 2022 projections, when borrowing was set to total less than 2% of GDP from 2023-24 onwards. It should be noted these forecasts are based on market interest rate expectations. Borrowing could thus be lower if interest rates turn out lower than these expectations.
Given the state of public finances the Chancellor has announced a new fiscal framework, which is less constraining than previous fiscal targets. As before, there are two fiscal targets – one for the budget deficit and one for government debt. While previously, the deficit goal was to have no current terms budget deficit (which excludes government investment) within three years, the new goal is for a total budget deficit of less than 3% of GDP within five years. In terms of total debt, the previous goal was to have government debt as a share of GDP falling within three years. The new goal is to achieve this outcome within five years.
Beyond the fiscal tightening other measures of interest for London announced in the Autumn Statement include that the Government has reversed plans for Investment Zones. Thus, existing expressions of interest will not be taken forward. Instead, the Government plans to support a limited number of the highest potential knowledge-intensive growth clusters. Beyond this it was also announced that the Government is planning to proceed with business rates revaluation in April 2023.
The Statement also confirmed that the second round of the Levelling Up Fund will allocate at least £1.7 billion to local infrastructure projects. Successful bids will be announced before the end of the year. The government will explore with the Greater Manchester Combined Authority and the West Midlands Combined Authority the potential to provide single departmental-style settlements at the next Spending Review. It will consider the eligibility of other mayoral combined authorities for these settlements.
Inflation grinds higher as energy and food prices surge
In another piece of bad news for the economic outlook, Consumer Price Index inflation accelerated to 11.1% year on year in October – the fastest pace of inflation since 1981. The main driver was a nearly 25% increase in household energy bills as the Energy Price Guarantee (EPG) came into action. The EPG currently caps unit costs at an equivalent to average household bills of £2500, but this is still a significant jump from the previous Ofgem price cap that implied average annual bills of just under £2000 a year. Nevertheless, with wholesale gas prices surging in August and September, previous estimates of the Ofgem cap would have implied an average household bill of over £3,500.
The other major pressure came from food, where prices were up 16.4% year on year – and the ONS estimates this is the fastest reading since 1977. Dairy was a particular pressure, with average prices for milk, cheese and eggs rising more than 27% annually.
Both these categories highlight the global inflationary impact of Russia’s invasion of Ukraine. While Russia’s status as the second-largest producer of oil and gas makes higher energy costs an obvious result of the war, Russia is also the world’s largest exporter of fertiliser. Both Russia and Ukraine are also major grain exporters. Disruptions to these markets mean that the war in Ukraine has resulted in soaring costs for feeding and grazing livestock for farmers worldwide. But inflation is certainly not restricted to specific areas of the basket, with it becoming increasingly broad-based. Services inflation, which tends to reflect broad domestic cost pressures, rose again to 6.3% year-on-year, while wider non-energy, non-food inflation held at an annual pace of 6.5% for a second month.
On average, Londoners tend to devote a smaller share of their spending to energy than households in other regions, but this is much less true for food. And in general, across the UK, lower-income households devote a larger share of their spending to food, energy and other essentials. Yet a struggle to pay the bills is not restricted to the lowest-income households. October polling by YouGov, commissioned by the GLA, showed that 44% of Londoners believe that they will definitely or probably struggle with energy bills in the next six months (Figure 3).
Looking ahead, the Bank of England and the OBR agree that while inflation is likely to hold around current levels over this winter, the pace of price increases should decelerate sharply from the middle of 2023. While the Bank still expects inflation to be at around 5% year on year by the end of 2023, it is then set to drop below 2% as soon as spring 2024 – and to approach 0% by the end of 2025. The OBR goes even further, expecting deflation by mid-2024.
Part of the underpinnings of these forecasts comes from the part-extension of the EPG after next April. While the Bank of England did not know whether the EPG would continue when it made its forecast, policymakers assumed some extension was likely – and the final scheme is close to their assumptions. Ultimately, the EPG will still cap unit prices, but in line with average annual bills of £3000 – i.e. an increase of 20% for many households. There will also be more targeted direct income support for those on means-tested benefits, those on disability benefits and anyone claiming a state pension. However, these supplements will not show up in aggregate inflation figures, helping keep inflation elevated close to current levels up to around halfway through 2023.
While the partial extension of the EPG will give London households better certainty around their bills in the future, London businesses have almost no guidance on what will happen to support for their energy costs beyond April 2023. A sharp surge in business costs could see inflation across the economy persist for longer.
World economy facing challenges
It is not just the UK which is facing economic challenges, with the world economy also showing signs of weakness. For example, the European Central Bank (ECB) has continued to raise interest rates in the Eurozone with rates being increased by 75 basis points to 1.5% in October after being below zero for eight years when rates began to rise in July 2022. ECB policymakers have suggested more rises are needed. This was seen when Joachim Nagel, the President of the Deutsche Bundesbank said that the ECB should “press ahead with monetary policy normalisation with determination — even if our measures dampen economic growth”. Looking forward the latest economic forecast from the European Commission expects both the Eurozone and wider EU to enter a recession with output in both areas expected to fall in Q4 2022 and Q1 2023. Still the Eurozone and EU are expected to grow next year by 0.3%. Elsewhere the International Energy Agency has sounded “the alarm bell” for gas prices next year, warning European leaders to not become complacent due to recent price falls. They thus warned that “we think gas markets will still be tight and volatile. This is an alarm bell for next winter as we believe we need to take immediate action now to avoid a shortage next year”.
China’s economy also faces challenges with exports dropping for the first time since 2020 due to a slowing global economy and the impact of its zero Covid policy. Exports thus fell by 0.3% year on year in October compared to 5.7% growth in September. The zero Covid rule is also impacting business confidence in Chinese cities, with, for example, a survey of companies in Shanghai by the American Chamber of Commerce finding that around a fifth of the 307 surveyed companies were pulling back on investment mostly due to Covid-19 measures.
Still the picture for the US economy is slightly more optimistic. Thus, although job growth slowed in October, it remained solid with the US adding 261,000 jobs. US inflation also dropped slightly in October to 7.7% down from 8% in September.
London stock exchange loses out to Paris
The French stock exchange has narrowly overtaken the UK’s in terms of the value of companies listed on it according to Bloomberg analysis. This found that all companies listed on the French stock market were worth $2.823 trillion compared to $2.821 trillion for the UK. Back in 2016 the value of companies on the UK stock market were collectively worth $1.5 trillion more than those on the French market.
London’s prime property market is also suffering in the aftermath of the September mini-Budget according to analysis by LonRes. This found that since then 262 prime home sales have collapsed, an 82% increase on the same period last year. Commenting on this Anthony Payne, managing director of LonRes, said “there is a pause in the market which is a direct result of the mini-Budget, and which I suspect will lead to price reductions”. Looking at commercial property, firms that own property in the west end have reported falls in the value of their estates. Thus Capital & Counties which owns Covent Garden said the value of its estate had dropped by 2% in the three months to the end of September, while Shaftesbury which owns Carnaby Street and Chinatown said its portfolios value had declined by 3.6% in the six months to the end of September.
London’s economy is thus facing a challenging end to the year with indicators such as the business activity PMI showing a decline in activity in October, its first decline since January 2021. GLA Economics will continue to monitor these and other aspects of London’s economy over the coming months in our analysis and publications, which can be found on our publications page and on the London Datastore.