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No new year cheer for UK economy with productivity and business investment weakening – CBI Economic Forecast

After a turbulent year both politically and economically, the CBI’s outlook for the economy strikes a somber tone as we go into 2023. The Prime Minister and Chancellor have stabilized financial markets but must act to boost long-term growth according to the latest CBI economic forecast.

  • GDP growth forecast downgraded for 2023 - economy expected to contract by 0.4% next year
  • Productivity remains weak – 2% below pre-pandemic trend at end-2024
  • Business investment forecast to be 9% below pre-pandemic levels
  • Year-long fall in consumer spending as squeeze on households continues into 2023
  • Inflation expected to have peaked, but will remain significantly above Bank of England target next year

Economic growth can only come from increasing productivity and maximising our workforce. When fiscal and monetary policy is tight, Government must use all levers at their disposal to move the UK economy beyond this current trajectory.

This includes addressing skill and worker shortages and unlocking business investment through capital allowances and regulatory changes, such as removing the de facto ban on onshore wind, improving mobility to facilitate trade in services and updating the national planning policy framework.

With three-quarters of firms facing shortages, we need a joined-up plan that addresses this. This should include co-ordinated action to enable upskilling and automation across businesses to ease pressures, as well as reducing economic inactivity, supported by a more flexible immigration system.

In addition, Government must act now to boost business investment and when the fiscal environment allows, they should look to introduce a permanent full allowances regime to unlock an extra £50bn in capital investment per year by the end of the decade.

The economy is likely to have fallen into a recession in Q3 2022, when GDP shrank by 0.2%. We expect the recession to last until the end of 2023 – as a result, we have downgraded our GDP growth outlook significantly, to -0.4% in 2023 (from 1.0% in our last forecast).

High inflation is at the heart of weaker economic activity. We expect CPI inflation to have peaked in October (at a 40-year high of 11.1%), and to fall gradually over the coming year. But it will remain significantly above the Bank of England’s 2% target over 2023, ending the year at 3.9%.

This means that the squeeze on households seen this year persists into 2023, leading to a year-long decline in consumer spending.

The weakness in household spending also weighs on other areas of the economy. In particular, business investment continues to disappoint, falling from mid-2023 onwards, hit by the recession and the government’s super deduction coming to an end.

The outlook improves in 2024, when the economy grows by 1.6%, thanks to inflation falling back further and the squeeze on household incomes alleviating. The recovery in household spending also lifts business and residential investment.

But despite the return to growth, longer-term economic prospects remain lacklustre. Productivity remains subdued in our forecast – by the end of 2024, we expect output per worker to remain 2% below its (already weak) pre-COVID trend, and 19% below a continuation of its pre-financial crisis trend.

Similarly, another bout of weakness in business investment leaves it still 9% below its pre-COVID level at the end of 2024.

This combination of prolonged weakness in productivity and investment, alongside another recession, leave their mark on the UK economy. By the end of our forecast, UK GDP remains 8% below its pre-COVID trend (from 2010 to 2019), and 27% below its pre-financial crisis trend.

Tony Danker, CBI Director-General, said:

“Britain is in stagflation – with rocketing inflation, negative growth, falling productivity and business investment. Firms see potential growth opportunities but a lack of “reasons to believe” in the face of headwinds are causing them to pause investing in 2023. Government can change this. Their action or inaction to support growth and investment will be a key determinant of whether recession is shallow or deep.”

“We will see a lost decade of growth if action isn’t taken. GDP is a simple multiplier of two factors: people and their productivity. But we don’t have people we need, nor the productivity”

“There is no time to waste. The Prime Minister and Chancellor must use levers of growth to ensure this downturn is as short and shallow as possible, but also to address the persistent weakness in investment and productivity. We cannot afford to have another decade where both are stagnant”

Alpesh Paleja, CBI Lead Economist, said: 

“Another recession in the space of two years is tough going. A second year of high – albeit falling – inflation will hit households hard, especially those lower down the income distribution. With cost pressures remaining high, many businesses will also be operating in a tough trading environment.”

“While it’s some consolation that the upcoming recession will be shallow, it’s concerning that longer-term weakness in productivity and business investment appears to be bedding in. It does not bode well for living standards and the economy’s capacity to grow over the longer-term.”

"The time for action is now. The Government should leverage more business investment to drive growth. Our analysis shows a permanent full allowances regime would unlock an extra £50bn in capital investment per year by the end of the decade”

Key forecast data

Growth

  • We expect UK GDP growth of 4.5% this year, -0.4% in 2023 and 1.6% in 2024. Our expectation for growth over 2023 marks a significant downgrade from our last forecast in June (1.0%)
  • Our forecast suggests that the economy has effectively entered a recession, which will last until Q4 2023. But we do expect this recession to be a relatively mild one, with a peak-to-trough fall in output of 0.7%
  • We expect GDP to return to its pre-COVID level (i.e., in Q4 2019) only in Q2 2024
  • However, both household spending and business investment do not recover this shortfall – remaining below their pre-COVID level at the end of our forecast (by 2% and 9% respectively)

Productivity & business investment

  • Much of the structural weakness in the UK economy that was apparent before COVID remains over our forecast
  • Productivity stays lacklustre, remaining 2% below its (already weak) pre-pandemic trend (i.e., the trend seen from 2010 to 2019)
  • Furthermore, business investment is expected to remain 9% below pre pandemic levels at the end of our forecast, even accounting for some recovery over 2024

Inflation

  • We expect CPI inflation to have peaked in October, when it hit a new high of 11.1% - largely driven by Ofgem’s energy price cap moving to the higher
  • level of the government’s Energy Price Guarantee
  • But while we expect inflation to fall back, it remains high over 2023 – averaging 6.7% over the year as a whole, still well above the Bank of England’s target
  • However, risks to the inflation outlook remain high, and particularly dependent on how global prices pressures evolve over the year ahead

Jobs

  • The UK’s labour market remains tight, but there are early signs of labour demand softening. We expect weaker activity to weigh on the labour market, with unemployment rising modestly next year. The unemployment rate peaks at 5% in late 2023/early 2024 (from its current level of 3.6%), before falling back to 4.5%.
  • Overall, this marks only a modest rise in unemployment, so it is possible that some degree of tightness in the labour market persists

Global themes

  • High inflation is a phenomenon seen across most advanced economies, in the year ahead, compounding the squeeze on global household incomes.
  • As a result, we have downgraded our outlook for global growth significantly: expecting world GDP to rise by 2.0% in 2023 (in purchasing power parity terms), from 3.2% in our previous forecast
  • In particular, the outlook for the UK next year is among the weakest out of the advanced economies that we forecast, with GDP only in Germany set to fall at a somewhat faster pace (-0.6%)
Original article link: https://www.cbi.org.uk/media-centre/articles/no-new-year-cheer-for-uk-economy-with-productivity-and-business-investment-weakening-cbi-economic-forecast/

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