Inflation and insolvencies cloud UK outlook

3 November 2023

The UK economy looks likely to avoid recession this year, but inflation, higher financing costs and a sharp rise in insolvencies continue to weigh heavily on UK businesses.

The UK economy staged a welcome albeit minor bounce back in August. Driven predominantly by the services sector, monthly real gross domestic product (GDP) grew by 0.2% in August, following a fall of 0.6% in July, according to the latest ONS figures.

Despite significant headwinds, including high-interest rates, rising labour costs and still high energy costs,  a recession will probably be avoided, but the UK is heading towards two years of almost zero growth. At Allianz Trade, our forecasts stand at +0.3% and +0.6% in 2023 and 2024, respectively.

The UK economy has proved relatively resilient to ongoing global macroeconomic and geopolitical trends. While a worldwide economic slowdown has been a drag on export activity in 2023 – with exports decreasing by -3.1% year on year – domestic demand has held up. UK households entered the tightening cycle with a large stock of savings, while many outstanding mortgages have been shielded from interest rate hikes by fixed deals.

Sticky inflation

The UK inflation rate has fallen from its 11.1% peak in October 2022, yet remains high. The Consumer Prices Index was unchanged at 6.3% in September, as resurgent fuel prices offset lower prices from food and non-alcoholic beverages.

Inflation is likely to remain elevated for the remainder of 2023. We forecast inflation at slightly below 5% by December, and think it is unlikely to fall below 3% during 2024. Wage growth and the recent escalation of conflict in the Middle East, which has caused oil and gas prices to climb further, point to a possible protracted period of elevated interest rates and could delay first rate cuts to end-2024.

The Bank of England held interest rates at 5.25% in September, its first pause after 14 consecutive rises since December 2021. However, with the inflation rate expected to run higher than the nominal interest rate for the remainder of this year, the Bank has room to increase interest rates to cool down demand, notably in the services sector. We expect the peak in Bank of England’s key interest rates still ahead of us, at 5.75%.

Wage growth

The UK job market remains tight despite a slow post-pandemic rebalancing. Job vacancies in the period July to September 2023 stood at 988,000, a decrease of 43,000 from the previous quarter, although total vacancies remained above their pandemic level. However, despite labour shortages cooling, there seems to be no turning point in wage growth.

Average pay growth between June and August rose above inflation for the first time in almost two years, according to ONS data. Wages rose at an annual rate of 7.8% between June and August, one of the highest regular annual growth rates since comparable records began in 2001. The finance and business services sector saw the largest annual regular growth rate at 9.6%, followed by the manufacturing sector at 8%. We expect wage growth at 8% in 2023, followed by 5.2% and 3.2% in 2024 and 2025, respectively.

Total real wage growth has been positive since June, and since April in the services sector. This is a trend to monitor in the coming months as a wage-price loop could become a real risk if real wage growth is positive during three out of the next four quarters. In October, the Chancellor announced an increase in the National Living Wage to two-thirds of average earnings, which would support an acceleration in real wage growth.

Rising business insolvencies

According to our latest Global Insolvencies Outlook, the number of insolvencies worldwide shows an upward trend in three out of four countries. Most are seeing double-digit rebounds, while 11 countries that account for 40% of global GDP registered a more than +30% surge in insolvencies in the year to date. Under pressure from weaker-for-longer demand and prolonged high financing costs, global insolvencies are expected to further accelerate in 2024, before stabilising with a limited improvement in 2025.

The UK is already seeing a sharp acceleration of business insolvencies from weak demand and higher costs, including higher labour costs. We expect business insolvencies to increase by 16% this year and 5% next and stay around 30% above pre-pandemic levels until 2025. All sectors have significantly crossed 2019 insolvency levels, although hospitality, trade, and manufacturing are the key contributors to the 2023 increase.

A succession of shocks and challenges over the past three years, including Brexit-related issues, Covid-19 and inflation, have left many UK firms fragile. The weakening resilience of some large firms threatens to create a domino effect, boosting insolvencies of smaller firms, due to their long lists of suppliers. We expect this fragility to remain in 2024-25, given that the economic and financing outlook will only moderately improve by 2025, and firms will be exposed to the debt-repayment wall. We estimate that 15% of SMEs in the UK remain at risk of default in the coming four years because of weak fundamentals, compared to 14% in France, 9% in Italy and 7% in Germany.

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