OECD Economic Outlook, Volume 2023 Issue 2

United Kingdom

GDP growth is projected to pick up from 0.5% in 2023 to 0.7% in 2024 and 1.2% in 2025. Private expenditure will replace government consumption and investment as the main driver of growth, helped by easing price pressures. Headline inflation will subside from historically high levels but remain above target over most of the projection period. Core inflation will linger at 3.8% in 2024 and 2.6% in 2025 on the back of the tight, albeit easing, labour market. Unemployment will edge up to 4.9% in 2025.

The fiscal stance is becoming restrictive and adequately supports monetary policy, which is expected to remain tight until price pressures ease sustainably. Continuing to address fiscal challenges is a priority, including by swiftly implementing planned supply-side reforms to boost potential growth. Better land‑use planning regulations are necessary for the timely rollout of decarbonisation investments.

Monetary tightening is working its way through the economy

GDP is estimated to have stagnated in the third quarter, after growing by 0.2% in the second quarter. Retail sales volumes are falling and were 2.7% lower in October than in the same month a year earlier. Consumer confidence remains depressed, although it is markedly higher than a year ago. New mortgage lending has continued to decline, with fewer than 45 000 new approvals for house purchase in September, down from almost 100 000 in January 2021 when the monetary tightening cycle started. After a short-lived pick up, business sentiment in services has deteriorated again. Lending to businesses contracted by 1.5% over the year to September.

United Kingdom: Inflation and interest rates indicators

1. Average quote for 5-year fixed rate (75% LTV).

2. Sterling weighted average rate on loans and new advances to private non-financial corporations.

Source: Bank of England; and Office of National Statistics.

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United Kingdom: Demand, output and prices

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United Kingdom: Labour market and economic growth indicators

1. Share of active population aged 15 and over.

Source: OECD Economic Outlook 114 database.

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Lower wholesale energy and imported food materials inflation, and the appreciation of the sterling on a year earlier, are helping to tame price pressures. Annual inflation fell to 6.7% in September, and dropped further to 4.6% in October as the large base effect from the October 2022 increase in the regulated energy price disappeared. The labour market shows signs of easing, with unemployment picking up steadily since the spring and vacancies continuing to fall. However, wage growth remains high, with annual nominal regular pay growth in the private sector at 7.8% in the three months to September, down from 8.1% in the three months to August. This has contributed to enduring services price pressures and a major upward surprise in core inflation over the summer.

The policy mix is strongly restrictive

The Bank of England is assumed to maintain its base rate at the current value of 5.25% throughout 2024. In line with the Bank’s statement, the pace of quantitative tightening is assumed to increase, from GBP 80 billion in the twelve months to September 2023 to GBP 100 billion by September 2024, bringing the balance sheet to a total of GBP 658 billion. Monetary policy is expected to ease in 2025 as core inflation starts subsiding sustainably, with the base rate declining to 4% by the end of the projection period.

The fiscal stance will be restrictive in 2024-25, with assumed consolidation of almost 2% of GDP, as the government complies with its national fiscal rule of decreasing public debt within a five-year horizon. Energy support measures have been phased out and the energy price cap no longer binds. Fiscal pressure on households and businesses has increased significantly since the spring Budget, due to the freeze of income tax brackets and the corporate income tax rate increase. The government is also committed to increase defence spending from about 2% to 2.5% of GDP. In the longer run, the supply‑side measures in the Autumn Statement and spring Budget, including the cuts in national insurance contributions and the “full-expensing” investment allowance, could enable the government to reduce fiscal pressure by gradually increasing labour market participation and business investment. However, ageing and high inflation coupled with the triple lock will push up pension spending by about 0.8% of GDP by fiscal year 2027/28; the necessary public investments to decarbonise power, the built environment and industry amount to about 0.5% of GDP per year; and the rising take-up of electric vehicles will cost about 0.4% of GDP a year in forgone fuel duty by 2030.

Growth will remain stable but low

GDP will grow by 0.7% in 2024 and 1.2% in 2025, despite the restrictive policy stance. Private consumption will pick up as real wages finally grow due to fast nominal pay growth and lower consumer price inflation. However, monetary tightening is weighing on housing and business investment, higher fiscal pressure will reduce household disposable income, and uncertainty will continue to be a drag on trade. The labour market is set to loosen, thereby moderating real wage growth beyond a period of catch up to inflation, and unemployment will increase steadily to about 4.9%. The government deficit will improve from 5.5% of GDP in 2023 to 4.5% of GDP in 2024 and 3.7% of GDP in 2025, owing mostly to fiscal consolidation. However, public debt will remain above 100% of GDP and continue to increase over the projection period.

Significant risks surround the outlook. The relatively large proportion of inflation-linked public debt and the recent decrease in average debt maturity, combined with rising borrowing costs, leave little fiscal space to confront possible shocks, including potential further surges in wholesale gas prices due to Russia’s war of aggression against Ukraine and rising tensions in the Middle East. Renewed political uncertainty would affect households, firms and markets’ confidence negatively. A rundown of excess household savings and faster-than-expected negotiations of new trade relationships constitute upside risks.

Continuing to address fiscal challenges is urgent

Maintaining and strengthening current fiscal efforts is essential against the challenging backdrop of high borrowing and debt, and as higher debt interest payments have eroded fiscal headroom. Reforming the costly triple lock uprating of state pensions would help, by indexing pensions to an average of CPI and wage inflation, and by providing direct transfers to poor pensioners to mitigate poverty risks. Delivering on planned supply side reforms to reduce labour market inactivity and further reducing policy uncertainty for business investment would also improve fiscal sustainability by raising GDP. Enhancing framework conditions, especially land-use planning, is necessary to enable the investments required to reach net zero.