British economy was in recession at the end of 2023

Capital Economics predicts UK interest rates will fall rapidly

As he prepares for a general election, Rishi Sunak has been seeking to reassure Tory MPs that the economy is turning around, after business surveys showed a recovery in private sector activity in the first few months of the year.

Official figures have confirmed that the British economy went into recession at the end of last year, after the latest estimate found it contracted in the last two quarters of 2023.

In a blow to the UK government’s economic standing, the UK's Office for National Statistics, or ONS, said the economy, as measured by gross domestic product, shrank by 0.3% in the last three months of the year, unrevised from an earlier estimate.

It followed a contraction of 0.1% in the third quarter of 2023, confirming a technical recession — two consecutive quarters of negative growth.

As he prepares for a general election, Rishi Sunak has been seeking to reassure Tory MPs that the economy is turning around, after business surveys showed a recovery in private sector activity in the first few months of the year.

A steep fall in inflation in recent months is expected to prompt the Bank of England to start cutting interest rates this summer, easing the pressure on mortgage payers and indebted businesses.

However, one of the bank’s nine-strong monetary policy committee, which sets interest rates eight times a year, said that cuts “were a long way off”, dampening speculation that several reductions in the cost of borrowing would take place this year.

Speaking to the Financial Times, Jonathan Haskel said: “Although the fall in headline inflation is very good news, it is not informative about what we really care about: what we really care about is the persistent and the underlying inflation. I think cuts are a long way off.”  

The UK consumer prices index fell from 4% in January to 3.4% in February. The decrease was mainly due to declining energy and food price growth. Inflation in the services sector remained above 5%.

Mr Haskel said he was worried about the high level of wages growth. He added that interest rates should remain high until there was evidence that wages growth had settled at a lower level.

The bank’s governor, Andrew Bailey, said last week that interest rate cuts were “in play”, adding that he was increasingly confident inflation was heading towards its 2% target after it hit a peak of 11.1% in October 2022. Financial markets expect at least three UK quarter-point rate cuts this year.

The ONS said the latest GDP estimate for the final quarter of 2023 showed all three sectors of the economy — services, production and construction — experienced falling output. The figures indicated that a deeper recession was prevented by a rise in government spending.

Services declined by a milder 0.1%, compared with a 0.2% fall in the first estimate, but without making a difference to the overall decline in the wider economy, the ONS said.

Britain’s trade declined and household consumption also fell despite a fall in inflation towards the end of 2023. The ONS said retail sales had the largest monthly fall in December since January 2021, when covid restrictions were in place.

Ashley Webb, a UK economist at the consultancy Capital Economics, said: “The UK’s mild technical recession at the end of last year was as mild as previously thought and the economic recovery is probably already under way.” 

He said the firm’s forecast for the economic recovery in 2024 and 2025 was that it would be stronger than the Bank of England expects. The firm has predicted that inflation will fall further than the bank forecasts and that interest rates will be cut faster and further than current market pricing suggests. 

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