UK economy to fare worse than any other country in developed world this year, IMF forecasts
Britain’s economic reputation has been dealt a further blow after the International Monetary Fund (IMF) forecast that this year the UK economy will fare worse than any other country in the developed world – including Russia.
In the latest update of its economic forecasts, the IMF said that it expected the UK’s gross domestic product (GDP) to contract by 0.6% in 2023.
To add further humiliation for the chancellor and prime minister, even as Britain’s outlook was downgraded, most other countries around the world saw their forecasts upgraded.
But the Fund said that while the broader global economy was doing better than expected, with inflation having peaked and investment beginning to turn around, the UK economy would face a downgrade “reflecting tighter fiscal and monetary policies and financial conditions and still-high energy retail prices weighing on household budgets.”
The UK had previously been forecast to grow by 0.3% this year and 0.6% next year.
Now, said the Fund, it should expect -0.6% this year and 0.9% growth in 2024.
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‘It’s bad news for the UK economy’
The comments are especially awkward for the Treasury, which has been criticised by some for its plans to raise taxes and reduce the budget deficit in coming years, resulting in an increase in costs for businesses and households, even as they continue to battle a cost of living crisis.
Up until recently, chancellor Jeremy Hunt had contextualised the UK’s relatively weak growth by pointing to the fact that the IMF’s recent forecasts projected that a third of countries were facing a recession.
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IMF calling UK ‘a dud economy’
However, the Fund has now upgraded its growth projections for Italy and Germany, with the result that both will now grow more than the UK in 2023.
Indeed, Britain’s -0.6% GDP is the worst of any economy included in its latest forecast update, including Russia – which despite facing sanctions from most of the West is projected to grow by 0.3%.
The poor growth was blamed on three factors: the UK’s dependency on gas – which has rocketed since the invasion of Ukraine; the fact employment has not returned to pre-pandemic levels; and increasing interest rates which have made mortgage payments more expensive.
Pierre-Olivier Gourinchas the director of research of the IMF laid out the rationale at a press conference on Tuesday morning.
The UK has a larger share of energy that comes from natural gas, he explained, “with higher pass through to final consumers” which has resulted in a “stronger cost of living crisis in the UK”.
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Why EY sees weaker 2023 outlook
Chancellor says UK ‘not immune’ from pressure
Mr Hunt said of the forecast: “The governor of the Bank of England recently said that any UK recession this year is likely to be shallower than previously predicted, however these figures confirm we are not immune to the pressures hitting nearly all advanced economies.
“Short-term challenges should not obscure our long-term prospects – the UK outperformed many forecasts last year, and if we stick to our plan to halve inflation, the UK is still predicted to grow faster than Germany and Japan over the coming years.”
The IMF said it now expected the global economy to expand by 2.9% in 2023.
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Although this is down from the 3.4% in 2022, it is nonetheless 0.2 percentage points faster than the Fund previously forecast in October.
It said: “Adverse risks have moderated since the October 2022 [World Economic Outlook].
“On the upside, a stronger boost from pent-up demand in numerous economies or a faster fall in inflation are plausible.
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Truss grilled over dire economy forecast
“On the downside, severe health outcomes in China could hold back the recovery, Russia’s war in Ukraine could escalate, and tighter global financing conditions could worsen debt distress.”
After China’s decision to open up its economy and ditch its zero-COVID policy, the Fund upgraded its GDP projection from 4.4% to 5.2% this year.
It said the US would grow by 1.4%, rather than its previous projection of 1%.
Germany, which was previously forecast to shrink by 0.3%, is now slated to grow by 0.1%.
First things first: don’t panic.
What you need to know is this. The budget has not gone down well in financial markets. Indeed, it’s gone down about as badly as any budget in recent years, save for Liz Truss’s mini-budget.
The pound is weaker. Government bond yields (essentially, the interest rate the exchequer pays on its debt) have gone up.
That’s precisely the opposite market reaction to the one chancellors like to see after they commend their fiscal statements to the house.
In hindsight, perhaps we shouldn’t be surprised.
After all, the new government just committed itself to considerably more borrowing than its predecessors – about £140bn more borrowing in the coming years. And that money has to be borrowed from someone – namely, financial markets.
But those financial markets are now reassessing how keen they are to lend to the UK.
The upshot is that the pound has fallen quite sharply (the biggest two-day fall in trade-weighted sterling in 18 months) and gilt yields – the interest rate paid by the government – have risen quite sharply.
This was all beginning to crystallise shortly after the budget speech, with yields beginning to rise and the pound beginning to weaken, the moment investors and economists got their hands on the budget documentation.
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Chancellor challenged over gilt yield spike
But the falls in the pound and the rises in the bond yields accelerated today.
This is not, to be absolutely clear, the kind of response any chancellor wants to see after a budget – let alone their first budget in office.
Indeed, I can’t remember another budget which saw as hostile a market response as this one in many years – save for one.
That exception is, of course, the Liz Truss/Kwasi Kwarteng mini-budget of 2022. And here is where you’ll find the silver lining for Keir Starmer and Rachel Reeves.
The rises in gilt yields and falls in sterling in recent hours and days are still far shy of what took place in the run up and aftermath of the mini-budget. This does not yet feel like a crisis moment for UK markets.
But nor is it anything like good news for the government. In fact, it’s pretty awful. Because higher borrowing rates for UK debt mean it (well, us) will end up paying considerably more to service our debt in the coming years.
Rachel Reeves leaving 11 Downing Street before the budget. Pic: PA
And that debt is about to balloon dramatically because of the plans laid down by the chancellor this week.
And this is where things get particularly sticky for Ms Reeves.
In that budget documentation, the Office for Budget Responsibility said the chancellor could afford to see those gilt yields rise by about 1.3 percentage points, but then when they exceeded this level, the so-called “headroom” she had against her fiscal rules would evaporate.
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In other words, she’d break those rules – which, recall, are considerably less strict than the ones she inherited from Jeremy Hunt.
Which raises the question: where are those gilt yields right now? How close are they to the danger zone where the chancellor ends up breaking her rules?
Short answer: worryingly close. Because, right now, the yield on five-year government debt (which is the maturity the OBR focuses on most) is more than halfway towards that danger zone – only 56 basis points away from hitting the point where debt interest costs eat up any leeway the chancellor has to avoid breaking her rules.
Now, we are not in crisis territory yet. Nor can every move in currencies and bonds be attributed to this budget.
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Markets are volatile right now. There’s lots going on: a US election next week and a Bank of England decision on interest rates next week.
The chancellor could get lucky. Gilt yields could settle in the coming days. But, right now, the UK, with its high level of public and private debt, with its new government which has just pledged to borrow many billions more in the coming years, is being closely scrutinised by the “bond vigilantes”.
A Halloween nightmare for any chancellor.
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