Britain is expected to be the only major industrialised country to see its economy shrink this year after the impact of Liz Truss’s brief premiership prompted a sharp growth downgrade from the International Monetary Fund.
Adding to growing political pressure on Rishi Sunak after the sacking of the Conservative party chair Nadhim Zahawi, the Washington-based IMF warned on Tuesday it expected the UK economy to contract by 0.6% this year – 0.9 percentage points worse than it had pencilled in just three months ago and slower even than sanctions-hit Russia.
The IMF said that while the prospects for every other member of the G7 group of leading developed nations had improved or remained unchanged since October, rising interest rates and higher taxes had made the outlook for the UK gloomier.
Pierre-Olivier Gourinchas, the IMF’s economic counsellor, said 2023 would be “quite challenging” for the UK as it slipped from top to bottom of the G7 league table. “There is a sharp correction,” he added.
The UK chancellor, Jeremy Hunt, last week warned a sense of declinism was hampering the UK’s economic recovery, and has come under pressure to come up with a credible plan to boost growth. His speech, which focused on “enterprise, education, employment and everywhere”, was widely criticised by business leaders as being devoid of policies.
The UK growth downgrade came in the IMF’s update to its half-yearly World Economic Outlook (WEO) – a health check on the global economy published in April and October.
The October 2022 WEO was completed before the tax-cutting mini budget from the then-chancellor, Kwasi Kwarteng, in late September and pencilled in growth of 0.3% for 2023. In its update, the IMF said the UK had performed more strongly in 2022 than anticipated, growing by 4.1% rather than the 3.6% expected three months ago.
But it said the outlook for 2023 had deteriorated, with its updated forecast reflecting the higher taxes announced by Hunt after he replaced Kwarteng, the increase in interest rates from the Bank of England, tougher financial conditions for borrowers, and still-high energy prices. The Bank is expected to raise interest rates from 3.5% to 4% on Thursday.
“With inflation at about 10% or above in several euro-area countries and the United Kingdom, household budgets remain stretched. The accelerated pace of rate increases by the Bank of England and the European Central Bank is tightening financial conditions and cooling demand in the housing sector and beyond,” the IMF said.
Treasury sources said the IMF’s focus on the high level of inflation reinforced the need to tackle the UK’s cost of living crisis. They added that in 2021 Britain had outperformed forecasts made by the IMF and the Organisation for Economic Cooperation and Development.
Hunt said in response to the IMF forecasts: “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.”
Hunt, whose plan for growth includes developing the UK equivalent of California’s Silicon Valley, added: “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.”
Gourinchas said the UK’s high dependence on still-expensive natural gas, the “scarring” effect of the Covid-19 pandemic on the size of the workforce, and higher mortgage costs would have an impact on growth.
“All together these factors will lead to a fairly sharp retrenchment in activity this year,” the IMF official said. Of the other G7 countries, it revised up its growth forecasts for the US, Germany, Italy and Japan, while leaving them the same for France and Canada. Russia’s growth prospects have markedly improved, the IMF said, with higher military spending and buoyant energy exports leading to forecast expansion of 0.3% in 2023 – a 2.6 point upgrade.
Overall, global growth is forecast by the IMF to be 2.9% this year, 0.2 points higher than anticipated in October, while the projection for 2024 has been revised down by 0.1 points to 3.1%.
Gourinchas said even after the modest improvement in the global picture for 2023, growth would remain weak by historical standards, as the fight against the strongest inflationary pressures in four decades and Russia’s war in Ukraine took their toll.
“Despite these headwinds, the outlook is less gloomy than in our October forecast, and could represent a turning point, with growth bottoming out and inflation declining.
“Economic growth proved surprisingly resilient in the third quarter of last year, with strong labor markets, robust household consumption and business investment, and better-than-expected adaptation to the energy crisis in Europe.”
The IMF’s economic counsellor said he was also encouraged by signs that inflation rates were falling in many countries, even though core inflation – which excludes energy and food prices – had yet to peak in most cases.
“Elsewhere, China’s sudden re-opening paves the way for a rapid rebound in activity. And global financial conditions have improved as inflation pressures started to abate. This, and a weakening of the US dollar from its November high, provided some modest relief to emerging and developing countries,” Gourinchas said.
“On the upside, a stronger boost from pent-up demand in numerous economies or a faster fall in inflation are plausible. 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.” Financial markets might also respond badly to higher than expected inflation news, the IMF added.
