The recession, which started in the third quarter of 2022, is likely to be fairly short and very mild, by comparison with previous ones. GDP in real terms (that’s to say after taking account of inflation) is forecast by HSBC to contract by not much more than 1%, as against the falls of around 6% suffered in the early 1980s and again in 2008-09. But while the economy should start to grow again later in 2023, it’s going to be well into 2024 before it’s the same size as it was before Covid struck. Taking 2023 as a whole, real GDP is expected to contract by 0.6% compared with last year, with a sluggish revival of 1.5% penciled in for 2024.
The reason that the economy finds itself in a recession is primarily the sharp squeeze on the spending power of households, brought about by very high gas and electricity prices and more generally by the fact that inflation has been running well ahead of the increase in earnings. Although inflation is now set to ease, having peaked at 11.1% last October, getting it back to the government’s target of 2% is likely to take at least three years. But, once inflation is back roughly in line with earnings growth, then the squeeze on living standards will abate, allowing the economy as a whole to start expanding again.
With many people forced to cut back on day-to-day spending, the retail and hospitality sectors will face an especially challenging time, with smaller businesses being particularly hard hit by huge increases in their energy bills. But, with some people still able to draw on savings put away during the pandemic, other activities, such as travel and leisure, may be less affected. House prices started falling towards the end of last year, and this trend is set to continue throughout 2023, with higher borrowing costs more than offsetting the shortage of supply. But, assuming that the peak of the interest rate cycle is close at hand, the drop in prices should be confined to around 5%.
Of course, what happens to the economy isn’t just about consumers (though with spending by households accounting for nearly two-thirds of GDP, when measured in terms of expenditure, it’s hard for the other elements to counteract the effects of falling real household incomes). But, with much of the rest of the world either in recession or close to it, 2023 is likely to be challenging for exporters. Meanwhile, given the uncertainties of the present environment, the ongoing challenge of containing costs, and the imminent end of the “super deduction” investment incentive, many businesses aren’t in the mood for shelling out on capital investment projects.
The weakness of demand, coupled with higher input prices, labour costs, and interest rates, will make 2023 a tough year for many businesses, irrespective of which sectors they operate in. The number of failures has already risen sharply, and will very likely rise further, but should remain below the levels seen back in 2008-09. For one thing, this recession is nothing like as severe. And many firms are, like households, still sitting on reserves of cash built up during the pandemic, added to which businesses in general are carrying less debt than they were 15 years ago. While the economy is contracting, turnover and costs are still rising, thanks to inflation, which means that working capital needs will also keep growing.