UK To Avoid Recession In 2023 – Lombard Odier

Editorial Staff 29 March 2023

UK To Avoid Recession In 2023 – Lombard Odier

After the UK’s Spring Budget, Stéphane Monier, chief investment officer at Lombard Odier, discusses how the UK’s economic prospects are looking up, with the country narrowly expected to avoid a recession in 2023.

Despite the recent inflation highs, UK interest rates look close to peaking and the economy should avoid recession this year, Stéphane Monier, chief investment officer at Lombard Odier, said in a statement this week. 

“Politicians face tough challenges on raising living standards, boosting productivity and getting people back to work, but the outlook has brightened in recent months,” he continued.

“The UK’s economic prospects are looking up. On 22 March, Bank of England governor Andrew Bailey said he felt ‘more optimistic’ on the outlook, even after the Bank raised interest rates to a 14-year high of 4.25 per cent,” he said. 

“In mid-March, updated forecasts from the independent Office for Budget Responsibility showed UK growth contracting just -0.2 per cent this year, up from the -1.4 per cent it expected in November. That would mean no technical’ recession, defined as growth falling over two consecutive quarters. The OBR now sees inflation falling to 2.9 per cent by year-end. It also expects chancellor Jeremy Hunt to meet his own fiscal rule of reducing net debt as a percentage of GDP over five years, although only just,” he continued.

Growth-friendly measures
An improving growth and inflation picture gave the chancellor room to announce tax cuts and spending increases, which are largely being targeted in a growth-friendly way. Plans to boost labour market participation include extending a scheme of 30 hours a week government-funded childcare for three-year-olds to younger children. The OBR believes that this could bring 75,000 more people into paid work. More emphasis was also placed on encouraging retirees and those on universal credit back into employment, he added.

Meanwhile, plans to raise investment include new allowances for large companies to offset capital spending against their tax bill. Tax-free annual allowances for payments into pensions were raised, and a lifetime cap on the amount that can be contributed before having to pay extra tax was abolished. The government hopes that this will help keep older workers, mostly in healthcare, practising for longer. More defence spending and support for artificial intelligence technologies should also help growth, he said.

Stability or stagnation?
“But the budget had few new measures to help the healthcare system, where long waiting times for treatment and cuts to mental health services could be thwarting efforts to get people back to health and employment,” he continued.

While tackling chronic public and private sector underinvestment is also much needed, new investment allowances are only planned to last three years. Companies are thus likely to simply shift investment plans forward, rather than increase them permanently. “Plans to boost economic productivity require long-term commitments, such as those laid out in the US Inflation Reduction Act or the EU Green Deal,” he said. 

“A limited recovery forecast post-2023 shows the UK economy continues to lack dynamism, while the cost-of-living crisis – also the source of many of the UK’s ongoing pay disputes – continues to bite. Household incomes, adjusted for inflation, are forecast to fall 6 per cent this year and next, and living standards will not recover to pre-pandemic levels until 2027, the OBR forecasts,” he said.

Rates could peak in May
“That said, the situation now looks to be slightly improving in 2023, helping consumer and market sentiment,” he continued. Retail sales rose again in February, while a key survey of consumer confidence rose in March, although it remains in negative territory. Price rises are certainly on consumers’ minds. Yet while the consumer price index rose unexpectedly to 10.4 per cent year-on-year in February, it is expected to fall fast in the coming months, aided by government help on energy bills. This would be good news for the Bank of England, which also has an eye on financial stability in the wake of recent bank failures. “Depending on how price pressures evolve, we believe an additional 25 basis points hike to 4.5 peak in May could represent the peak of its hiking cycle,” he said. 

“On the political front, UK Prime Minister Rishi Sunak has also made good strides improving relations with the EU. The UK and EU have now formally adopted a deal to resolve a post-Brexit trade dispute involving Northern Ireland, although it still faces opposition from Northern Ireland’s Democratic Unionist Party,” he said. 

“Relations are also brightening with France, where a recent meeting with President Emmanuel Macron was the first bilateral summit between the country’s leaders in five years, and where the pair agreed a new framework to manage undocumented migrants crossing the channel,” he added.

“Reflecting the improving political and growth outlook, sterling has risen against both the US dollar and euro in the past month,” he said. “However, over a 12-month horizon, we expect it to lose ground, given improving real yields available elsewhere and the currency’s historical underperformance in periods of financial stress,” he added. UK 10-year government bonds are currently yielding around 3.36 per cent, down from highs of 4.47 per cent in the aftermath of the autumn mini-budget. Meanwhile, the UK’s FTSE 100 index looks attractively valued, but concerns over the health of the financial sector may continue to weigh on stock markets in general – and the UK’s bank-heavy index – for now.

“For this reason, we retain our overall neutral stance on equities, and a balanced approach to risk across client portfolios,” he concluded.

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