Alex Chappell

15th October, 2021

Blog, IC Insights

Could the UK fall back into recession next year?…

Rising prices, record job vacancies (apparent full employment) and upcoming tax rises… not really an ideal set of economic circumstances heading into 2022! Consequently, many commentators are suggesting we may not be far away from a second recession in three years. Yet the Bank of England continue to talk up the potential for interest rate rises, which is normally done to cool down a buoyant economy. There is a conflict of information here, so who do we believe and why?

The short answer is neither, but there is context that’s worth elaborating on. On the one-hand, the average household’s disposable income will almost certainly be lower in 2022 than in 2021. A combination of health and social tax costing 1.25%, and current inflation which is running 3.2%, are eroding the purchasing power of income streams. To some extent that will be offset by rising wages, but not by enough in aggregate. Naturally that should reduce consumer spending levels, and with the UK economy being largely consumer based, that’s not ideal.

The treasury is reducing it’s rate of spending as well, with furlough coming to an end, and the Bank of England starting to reign in their money printing. Neither are particularly ideal with COVID still hanging around in the background, even if the chance of restrictions being reimposed seems low at the current time.

It’s not perfect out there then, but whether it’s bad enough to send us into recession is another matter altogether. It’s worth remembering that in part helped by the financial stimulus used to get us through the crisis, and the restraint from not being able to go out, that household balance sheets are very healthy comparative to pre COVID.  Moreover, the average person is arguably more financially efficient now, travelling and generally spending less than pre COVID times.

The net position of all that is that growth probably slows into next year but doesn’t go negative. It would be a policy error in our view, for the Bank of England to raise interest rates, and our base case is that they defer until 2023 once they can see that growth has returned on a better footing. That would be a positive for those with mortgage rates that are up for renewal next year and be one less thing the UK consumer has to worry about.

Investment markets have already priced in two rate rises, one in November and the other in March. In part, this has been a contributor to market volatility in recent weeks. If the rate rise does not come to fruition, we’d expect UK bonds to do better than expected, and some areas of the equity markets to move forwards. In contrast, sectors that are more geared to a better UK economy could come under pressure, and across the summer we have rotated out of these areas, and into other opportunities, in anticipation.

Even if it’s not plain sailing next year then, it’s unlikely to be a shipwreck either. There will be uncertainty, which in markets creates volatility. For our portfolios this provides opportunities as we will of course be watching how things develop and adjusting our view as necessary, however for now we think concerns are overdone.