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UK economic outlook to ‘improve moderately’ but base rate still set to go beyond 5%

Growth forecasts have replaced negative expectations for the economy this year. However, experts predict the Bank of England base rate will keep on rising.

The economy is now forecast to grow by 0.3% in 2023, a brighter outlook from the OECD than its March prediction that the economy could head into a 0.2% downturn. GDP growth is expected to “improve moderately” to 1%, instead of the 0.9% interim forecast made in Q1.

Government spending on initiatives such as the energy support measures which contributed to growth in the second half of 2022 will carry over to the first quarters of 2023. The government’s spending will continue to “prop up” the economy before private spending becomes stronger as wholesale gas prices fall and the global economic conditions improve.

The OECD predicts that inflation, currently 8.7%, will slow following the decline in energy prices and will move down close to the 2% target by the end of 2024.

Core inflation is expected to be more persistent due to strong inflation in the services sector while unemployment is forecast to rise to 4.5% in 2024.

Speaking to the Financial Times, the new chief economist of the OECD Clare Lombardelli said the UK had a “particular issue about the labour market”. She said the size of the workforce had fallen after the pandemic, raising pressure on companies to pay people more.

The Government hopes that its free childcare initiative will encourage more parents back into work.

Base rate only going one way

As inflation remained higher than expected after the latest Consumer Price Index figures showed a rise of 8.7% in the 12 months to April, financial markets and economists have revised up their peak base rate predictions.

Deutsche Bank now expects the base rate to reach 5.25% by in the latter part of Q3 2023 and does not think the first base rate cut will appear until May 2024.

In its macro outlook, Higher for Longer, the bank wrote: “Why the rise in rate expectations? Simply, stubborn inflation and still very elevated wage growth (particularly in the private sector). We also think there is a real risk around price persistence later this year, even as inflation slows further from its multi-decade highs.”

A poll of 50 economists carried out by news agency Reuters found that the middle ground prediction for the direction of the base rate was a 25 basis point increase on June 23 when the Bank next meets taking the rate to 4.75%. A peak of 5% is forecast by the end of quarter three.

Capital Economics agrees that June will usher in a rise, driving the rate from 4.5% to 4.75% but it expects the base rate to top out at 5.25% in September. The financial markets are going a step further and pricing in a peak of 5.5%, fuelling the rapid withdrawal and repricing of mortgage deals.

Economists EY Item Club say rising mortgage rates are the “main headwind facing the housing market”. Around 2.5 million more homeowners will be moving onto a higher mortgage rate this year as fixed rates expire. The recent higher than expected inflation data, says EY, has pushed gilt yields towards levels not seen since last autumn’s mini Budget, prompting some lenders to withdraw and reprice and fixed rates.

It added: “The EY Item Club thinks it is very likely the Bank of England will raise interest rates again this month, and possibly again later in the summer. As a result, we think house prices are likely to continue drifting down, although avoiding a major correction.”

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