January 22nd, 2024

Good news for the Chancellor this week. The EY Item Club has upgraded growth forecasts for the UK economy.

Thanks to a combination of falling inflation, interest rate cuts and tax reductions, the economy will grow more than expected over the next few years. The latest projections from the EY Item Club suggest that annual growth will increase to 0.9 per cent in 2024 and by 1.8 per cent in 2025.

Martin Beck, chief economic adviser to EY Item Club, said: "The mood music around the economy is justifiably improving. High inflation and expensive borrowing costs have been two of the biggest obstacles to growth. With both showing encouraging signs of subsiding, prospects for late 2024 and beyond appear brighter."

Falling inflation should lead the Bank to make ""a more significant reduction" in rate cuts this year. EY expects the Bank's rate setting monetary policy committee will cut rates by 125 basis points this year to around 4%. This is 100 basis points lower than previously forecast.

The EY forecast are slightly more upbeat than the latest "Forecasts for the UK Economy"* released by HM Treasury last week. Growth is expected to be around 0.7% this year, in line with the OBR forecast of 0.7%. In the following year 2025, the OBR are anticipating growth of 1.4%. No forecasts for 2025 are as yet included in the Treasury survey.

Our scenario forecast would anticipate growth of 0.7% in 2024 following growth of 0.6% in 2023. Our provisional forecast for 2025 is 1.3% but much will change with an election in prospect this year.

Our outlook on inflation is unchanged despite the slight uptick in CPI inflation in December. In detail, inflation CPI basis eased up to 4.0% in December from 3.9% prior month. CPI(g) goods inflation moved to 1.9% from 2.0% prior month. CPI(s) Service Sector inflation moved to 6.4% from 6.3%. Core inflation was unchanged at 5.1%.

Food inflation eased to 8.0%, energy costs were down again by -21.5%. The increase in tobacco duties in the Autumn statement pushed tobacco prices higher, up by 16% year on year.

Despite the headlines of alcohol and tobacco pushing the headline rate higher, (Alcohol and tobacco account for just 4% of the shopping basket), the major uptick was in service sector inflation. This will remain sticky over the next six months.

Our outlook for the year remains unchanged. Inflation CPI basis averaged 4.2% in the final quarter of 2023. We would expect inflation CPI basis to fall to 3.5% by the end of the year. Service sector inflation will be resistant to a more rapid fall despite the further falls expected in energy prices in the Spring.

In the latest data average earnings, (whole economy) were up by 6.5% in November. We expect earnings to trend lower to 4.5% by the end of 2024, as unemployment rises and vacancies fall back towards 800,000.

Our forward guidance also remains unchanged, all things being equal, base rates could end the year at around the 4.5% level., with ten year gilts in tandem. This we think could well be the standard rate for life, following the great escape from Planet ZIRP.

So what of the election prospects?
The forecasts for the economy this year and next are looking better. The Chancellor will find some money for tax cuts in the budget on March 6th. A cut in the headline rate of income tax remains the forecast favourite. Inheritance tax may not poll, quite so well, in the focus groups. Tax relief for fox hunting, may also not make the cut.

If it's the economy that sways the votes, the Tories are in with a shout. If it's immigration, the boats and waiting lists, not quite so good. The latest opinion polls suggest Conservative prospects are looking pretty bleak ...