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UK Recession Risks Grow With Record Deficit and Output Slump

(Bloomberg) -- British companies signaled output dropped at the fastest pace since the start of the pandemic as the government budget deficit widened to a record, adding to evidence that the economy may be in a shallow recession.

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S&P Global said its index of sentiment from purchasing managers fell more sharply than expected in January, led by a deterioration in services that had previously propped up the economy. The Office for National Statistics reported the highest ever December shortfall after soaring interest rates jacked up the cost of debt service.

The figures eat away at hopes that the UK may avoid a slump. It adds to pressure on Prime Minister Rishi Sunak to come up with a growth program and defuse some of the labor and trade disputes that have brought some sectors to a standstill.

“Industrial disputes, staff shortages, export losses, the rising cost of living, and higher interest rates all meant the rate of economic decline gathered pace again,” Chris Williamson, chief business economist at S&P Global Market Intelligence, said in a statement Tuesday. He said the UK is also facing “ongoing damage to the economy from longer-term structural issues such as labor shortages and trade woes linked to Brexit.”

The pound dropped after the S&P release, falling as much as 0.6% to $1.2309, and UK government bonds extended gains. Traders also pared bets on the peak in the BOE’s key rate, pricing in around 101 basis points of additional hikes by August versus 105 basis points at Monday’s close.

What Bloomberg Economics Says ...

“The drop in January composite PMI suggests the UK economy may have fallen into recession at the start of 2023. Taken alongside evidence of easing price pressures, we think the survey supports our view that that Bank of England is nearing the end of its hiking cycle. We see a 50-basis-point hike in February and a 25-bps move in March, after which we expect a pause.”

—Ana Andrade, Bloomberg Economics. Click for the REACT.

So far, the UK has weathered soaring energy prices better than expected. The economy grew unexpectedly in the fourth quarter, dashing expectations that a recession started in the middle of last year. Even so, economists and the Bank of England expect a downturn for much of this year, with no growth before 2024 when the next election is due.

Sunak lifted tax rates to the highest since World War II to finance energy subsidies that are cushioning households from soaring natural gas and electricity prices. The public finances figures highlight both how much money the Treasury is draining from consumers in the form of tax and the government’s increasing struggle to finance health and welfare programs.

But a number of reports out Tuesday pointed to gloom. The number of British businesses at risk of going bust rose by more than a third at the end of last year, according to a report by consultancy Begbies Traynor. The Confederation of British Industry said factories are curtailing production at record rates on concern that cuts to government energy subsidies will drive up their costs.

“Global supply chain pressures, labor shortages and energy costs are easing, enabling unit cost growth to ease back from record highs,” said Anna Leach, deputy chief economist at the CBI. “But there are signs that demand is easing too.”

Those reports point toward a darkening outlook for the public finances. While inflation is boosting tax reciepts for now, it’s also costing the Treasury more in debt service payments.

The budget deficit stood at £27.4 billion ($34 billion), a record for the month and almost triple the £10.7 billion shortfall a year earlier, the ONS said. Economists had forecast a reading of £17.3 billion.

“Today’s worse-than-expected public finances figures will only embolden the Chancellor in the budget on 15th March to keep a tight grip on the public finances,” Ruth Gregory at Capital Economics wrote in a note to clients. It means he’ll “waits until closer to the next general election, perhaps in 2024, before announcing any significant tax cuts.”

The figures also show that soaring prices and tax rates are bringing more money into the Treasury. Total receipts leaped 11% to £658 billion in the financial year to December. VAT and income tax receipts grew at a double digit pace last month.

The massive cost of helping Britain through the living-standards crisis has dashed hopes that borrowing was on a downward path. Less than a year ago, the deficit was projected by the Office for Budget Responsibility to fall below £100 billion in 2022-23.

The cost of subsidizing gas and electricity is also taking a toll, amounting to £7 billion in December alone.

“We are helping millions of families with the cost of living, but we must also ensure that our level of debt is fair for future generations,” Chancellor of the Exchequer Jeremy Hunt said in a statement. “We have already taken some tough decisions to get debt falling, and it is vital that we stick to this plan.”

Read more:

  • UK Factories Curtail Production at Record Rate, CBI Survey Says

  • Money Distilled: UK Inflation May Fall Faster Than Expected

  • Number of UK Firms Facing Collapse Jumps by Over a Third

  • Britain’s Health Care Black Hole Is Devouring the Whole Country

--With assistance from Libby Cherry.

(Updates with CBI survey and insolvencies.)

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