Will the UK avoid recession?

First, let’s consider the size. The household price cap scheme is due to last for 18 months and although the government is briefing that the gross cost will be £90bn, a more realistic estimate is £120-140bn. The details of the corporate support scheme have not yet been released but this could add £60bn or so. This is on top of the cancellation of the planned rise in corporation tax and the roll back of the increases in National Insurance contributions. The support previously announced by Rishi Sunak will be maintained.

There will be offsets. Inflation will be lower, by 2.7% this year and 3% next, which will reduce payments on indexed linked gilts (partially offset by reduced income on student loans) and social security upratings.  And there will be some flow back to the Treasury in the form of higher tax receipts and lower unemployment benefits. Nonetheless, this all amounts to a massive fiscal stimulus of the order of 5% of GDP.

Without the new package a UK recession seemed inevitable. Growth may still slow but a recession looks set to be avoided. Quite an achievement for the new government.

That’s the good news. The bad news is that the stronger economy means that the Bank of England (BoE) will raise rates further. Data out this morning showed that wages have been accelerating at an annualised pace of over 6%, for the last 3 months, in the private sector. This a far too fast for the BoE.

Stronger demand will also lead to a wider balance of payments deficit. I covered this in my previous macro update. Even before the new package I thought that the current account deficit was unsustainable. It looks set to hit 5% of GDP this year before the package has had its effect. Avoiding recession and higher interest rates, should boost sterling but the big current deficit goes the other way. It’s a tough call but longer term I am worried about serious sterling weakness.

There is no uncertainty about the impact on gilts yields though. Huge government borrowing means higher yields. Government bond yields have been rising due to a hawkish European Central Bank and stronger US economic data. As the markets digest the scale of prospective borrowing, yields could rise further.

The surge in gas prices that led to all of this will probably push Europe, our biggest trading partner, into recession. The US Federal Reserve looks set to continue raising US interest rates until they can bring inflation down to their target and that probably needs a recession there too.

I’m left with the feeling that the UK will avoid a recession this winter but will still end up with a recession in 2023.