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New Year economic optimism might not outlast resolutions

 (ES Composte)
(ES Composte)

After a tough 2022, the turn of the year has brought some genuine signs of economic health. The big question is whether this new-found economic optimism will outlast most new year resolutions as well as the increasingly popular dry January and Veganuary.

There are three main ways in which the prospects for the economy have recently improved.

First, CPI inflation (which measures the change in the prices of the goods and services that we all buy) peaked at 11.1% in October last year, fell to 10.5% in December and may decline to around 4% by the end of this year. In particular, petrol prices have fallen from £2.00 per litre in July to £1.60 per litre now. And although the average annual household utility bill will rise from £2500 now to £3000 in April, the recent sharp declines in wholesale gas and electricity prices suggest it will fall back well below £2500 in July. These changes will mean inflation eats up less of households’ wages.

Second, interest rates are unlikely to rise as far this year as they did last year. The Bank of England’s policy rate, which goes a long way to determining the interest rates households and businesses pay on their mortgages, credit cards and loans, rose from 0.1% in November 2021 to 3.5% in December 2022. That’s the largest rise since the late 1980s. Interest rates will probably rise further in the first few months of this year, perhaps to 4.5%. But the biggest increases are now behind us.

Third, the economy is proving to be more resilient to the dual drags of high inflation and higher interest rates. This may be because the Government’s various handouts and energy price subsidies have significantly supported households’ incomes and businesses’ balance sheets. And some households may have been able to dip into savings they built up during the pandemic, while some businesses may have had money left over from the Bounce Back loans they took out during the pandemic.

As a result, it appears that last year the economy did not fall into a recession. All of this helps to explain why the FTSE 100 has risen since the start of the year, taking it close to an all-time high.

Unfortunately, there are two reasons why, just like many New Year resolutions, much of this economic optimism will be forgotten about in a couple of months’ time.

First, any spare savings, loans or money provided by the government can be spent only once. And lower inflation doesn’t mean that all prices will fall. Instead, aside from petrol prices and utility prices, most prices will continue to rise this year, just at a slower rate than last year. The recent announcements of job cuts by Amazon, Vodafone and Goldman Sachs show that big businesses are feeling the pinch too and are starting to cut costs.

Second, although the bulk of the rise in interest rates happened last year, most of the effects on the economy will be felt this year. Almost nine in 10 — 86% — of household mortgages are on fixed rates, most of which won’t have been affected by last year’s surge in quoted mortgage rates from 1.5% to 5.5%. But the fixed rates of 1.7 million households are due to expire this year. At that point, their monthly mortgage repayments will soar.

Similarly, most of the 12% decline in house prices that I warned about in these pages in November will take place this year. That will reduce spending in the economy as fewer new homes are built, fewer people move home and existing homeowners feel less well-off.

My suspicion is that the economy will fall into a recession in the first half of this year. Even if it doesn’t, it won’t grow much at all. And for many people, it already feels like a recession. More households are relying on food banks, resorting to buy now pay later deals and using cash as a way to control their spending because handing over a note feels more real than tapping a card.

Overall, my hunch is that 2023 won’t live up to the optimism of the first three weeks of the year. We might need to wait another 12 months before economic optimism outlasts most New Year resolutions.

Paul Dales is chief UK economist of the independent global research consultancy Capital Economics