UK economy to sidestep recession despite inflation: Lombard Odier

22 Jun '23

3 min read

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Insights

UK economy is expected to avoid recession due to improved relations with EU, stable fiscal policy, and lower energy costs, despite stubborn inflation, according to Lombard Odier.
The Bank of England (BoE) is likely to raise rates, with no easing until mid-2024.
Mitigation for labour market imbalances may come from strong net migration into the UK.

Despite the stubborn levels of inflation, the UK's economy is showing resilience and the prospects for growth have improved, according to Lombard Odier, a Swiss private bank. Improved relations with the European Union (EU), a more predictable fiscal policy, and lower energy costs are contributing to the growth outlook.

Only in January 2023, the International Monetary Fund (IMF) predicted that the UK economy would contract by 0.6 per cent this year, the worst performance among advanced economies. However, Lombard Odier now expects the UK to avoid recession and post slightly positive annualised GDP growth. In a remarkable turnaround, the IMF revised its growth outlook to 0.4 per cent in May 2023.

Despite these improvements, the UK is grappling with high inflation rates, notably core inflation excluding energy and food, which rose from 6.2 per cent in March to 6.8 per cent in April 2023. Consequently, the Bank of England (BoE) has not yet finished its job in stabilising prices. BoE will continue to raise rates in their next meeting on 22 June, with the benchmark rate potentially reaching as high as 5.5 per cent later this year. It seems unlikely that any easing will occur until mid-2024, as per Lombard Odier.

Despite high inflation, rising mortgage costs, and a tight labour market, UK wages have been increasing. However, inflation-adjusted real wages are still declining. As the labour market overheats, persistent price pressures are a growing concern. After eight consecutive months of declining unfilled job vacancies, a moderation in wage growth may signal a pause in monetary tightening.

Mitigation for labour market imbalances may come from strong net migration into the UK. The Office for National Statistics (ONS) reports that a record number of approximately 606,000 immigrants arrived in 2022, with the majority from countries outside the EU, including Ukraine and Hong Kong.

At a political level, prime minister Rishi Sunak's government has been working to restore confidence following a sterling and sovereign bonds collapse triggered by his predecessor's 'mini budget' in September 2022. The ‘Windsor Framework’ agreed in February 2023 has also been an attempt to clarify the trading position of Northern Ireland between the UK and the EU.

Inflation expectations are now driving up UK sovereign fixed income yields, with ten-year UK government bonds, or gilts, now yielding 4.38 per cent, a level last seen during Liz Truss's term as prime minister. Market expectations currently price the UK's interest rate cycle peaking around 5.8 per cent, reflecting the BoE's continued fight against persistently high inflation.

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