Last year was far from the picture of economic stability that all governments would hope for. Instead, the overarching theme of 2022 was uncertainty, which overshadowed many economic predictions throughout the year. The Collins English Dictionary announced that their word of the year for 2022 is ‘permacrisis’, which is defined as ‘an extended period of instability and insecurity’.
For the UK, 2022 was an eventful year, seeing two changes in prime minister, economic stagnation, financial turmoil, rampant inflation and a cost of living crisis. However, the UK was not alone in its economic struggles. Many believe that it is a minor miracle that the world did not experience a systemic financial crisis in 2022.
Russia’s invasion of Ukraine has led to the biggest land war in Europe since 1945, the most serious risk of nuclear escalation since the Cuban missile crisis and the most far-reaching sanctions regime since the 1930s. Soaring food and energy costs have fuelled the highest rates of inflation since the 1980s and the biggest macroeconomic challenge in the modern era of central banking (with the possible exception of the financial crisis of 2007–8 and its aftermath). For decades we have lived with the assumptions that nuclear war was never going to happen, inflation will be kept low and rich countries will not experience an energy crisis. In 2022 all of these assumptions and more have been shaken.
With the combination of rising interest rates and a massive increase in geopolitical risk, the world economy did well to survive as robustly as it did. However, with public and private debt having risen to record levels during the now-bygone era of ultra-low interest rates and with recession risks high, the global financial system faces a huge stress test.
Rishi Sunak, the UK Prime Minister, started 2023 by setting out five pledges: to halve inflation, boost economic growth, cut national debt as a percentage of GDP, and to address NHS waiting lists and the issue of immigrants arriving in small boats. Whilst most would agree that meeting these pledges is desirable, a reduction in inflation is forecast to happen anyway, given the monetary policy being pursued by the Bank of England and an easing of commodity prices; and public-sector debt as a percentage of GDP is forecast to fall from 2024/25.
Success in meeting the first four pledges will partly depend on the effects of the current industrial action by workers across the UK. How soon will the various disputes be settled and on what terms? What will be the implications for service levels and for inflation?
A weak global economy
Success will also depend on the state of the global economy, which is currently very fragile. In fact, it is predicted that a third of the global economy will be hit by recession this year. The head of the IMF has warned that the world faces a ‘tougher’ year in 2023 than in the previous 12 months. Such comments suggest the IMF is likely soon to cut its economic forecasts for 2023 again. The IMF already cut its 2023 outlook for global economic growth in October, citing the continuing drag from the war in Ukraine, as well as inflationary pressures and interest rate rises by major central banks.
The World Bank has also described the global economy as being ‘on a razor’s edge’ and warns that it risks falling into recession this year. The organisation expects the world economy to grow by just 1.7% this year, which is a sharp fall from an estimated 2.9% in 2022 according to the Global Economic Prospects report (see link below). It has warned that if financial conditions tighten, then the world’s economy could easily fall into a recession. If this becomes a reality, then the current decade would become the first since the 1930s to include two global recessions. Growth forecasts have been lowered for 95% of advanced economies and for more than 70% of emerging market and developing economies compared with six months ago. Given the global outlook, it is no surprise that the UK economy is expected to face a prolonged recession with declining growth and increased unemployment.
The current state of the UK economy
Despite all the concerns, official figures show that, even though households have been squeezed by rising prices, UK real GDP unexpectedly grew in November, by 0.1%. This has been explained by a boost to bars and restaurants from the World Cup as people went out to watch the football and also by demand for services in the tech sector.
At first sight, the UK’s cost of living crisis might look fairly mild compared to other countries. Its inflation rate was 10.7% in November 2022, compared to 12.6% in Italy, 16% in Poland and over 20% in Hungary and Estonia. But UK inflation is still way above the Bank of England’s 2% target. The Bank went on to tighten monetary policy further, by increasing interest rates to 3.5% in December. Further rate rises are expected in 2023. In fact, the markets and the Bank both expect the main rate to reach 5.2% by the end of this year. With the consequent squeeze on real incomes, the Bank of England expects a recession in the UK this year – possibly lasting until mid-2024.
The UK is also affected by global interest rates, which affect global growth. Global interest rates average 5%. A 1 percentage point increase would reduce global growth this year from 1.7% to 0.6%, with per capita output contracting by 0.3%, once changes in population are taken into account. This would then meet the technical definition of a global recession. This means that the Bank’s November economic forecast, which was based on a Bank Rate of 3%, may worsen due to an even larger contraction than previously expected. The resulting drop in spending and investment by people and businesses could then cause inflation to come down faster than the Bank had predicted when rates were at 3%.
There could be some positive news however, that may help bring down inflation in addition to rate rises. There has been some appreciation in the pound since the huge drop caused by the September mini-budget that had brought its value to a nearly 40-year low. This will help to reduce inflation by reducing the price of imports.
As far as workers are concerned, pay increases have been broadly contained, with 2022 being one of the worst years in decades for UK real wage growth. Limiting pay rises can have a deflationary effect because people have less to spend, but it also weighs on economic growth and productivity. Despite the impact on inflation, there is a lot of unrest across the UK, with strike action continuing to be at the forefront of the news. Strikes over pay and conditions continue in various sectors in 2023, including transport, health, education and the postal service. Strikes and industrial action have a negative effect on the wider economy. If wages are stagnating and the economy is not performing well, productivity will suffer as workers are less motivated and less investment in new equipment takes place.
The UK economy is also under threat of a prolonged recession due to the proportion of households that lack insulation against financial setbacks. This proportion is unusually large for a wealthy economy. A survey conducted prior to the pandemic, found that 3 million people in the UK would fall into poverty if they missed one pay cheque, with the country’s high housing costs being a key source of vulnerability. Another survey recently suggested that one-third of UK adults would struggle if their costs rose by just £20 a month.
The pandemic itself meant that over 4 million households have taken on additional debt, with many now falling behind on repaying it. This, combined with recent jumps in energy and food bills, could push many over the edge, especially if heating costs remain high when the present government cap on energy prices ends in April.
However, there could be some better news for households with the easing of COVID restrictions in China. This could have a positive impact on the UK economy if it helps ease supply-chain disruptions occurring since the height of the global pandemic. It could reduce inflationary pressure in the UK and other countries that trade with China by making it easier – and therefore less costly – for people to get hold of goods.
- Recession will hit a third of the world this year, IMF chief warns
- World Bank warns global economy on ‘razor’s edge’ of recession
- What’s in store for the UK in 2023? Here’s one economist’s view
- Global economy 2023: how countries around the world are tackling the cost of living crisis
- The world economy faces a huge stress test in 2023
- Why a global recession is inevitable in 2023
- Global economy of 2023 is going to be a wild ride
- UK economy beats expectations with November growth
Financial Times, Patrick Temple-West and Lauren Fedor (1/1/23)
Financial Times, Jonathan Wheatley (10/1/23)
The Conversation, Muhammad Ali Nasir (12/1/23)
The Conversation, various economists (6/1/23)
The Guardian, Kenneth Rogoff (5/1/23)
The Economist, Zanny Minton Beddoes (18/11/22)
Bloomberg, Stephanie Flanders (12/1/23)
BBC News, Dearbail Jordan and Faisal Islam (13/1/23)
- Global Economic Prospects
- UK Economic Outlook: Predictions for the year ahead 2023
World Bank (January 2023)
pwc (January 2023)
- Define the term ‘deflation’.
- Explain how an appreciation of the pound is good for inflation.
- Discuss the wider economic impacts of industrial strike action.
- Why is it important for the government to keep wages contained?