UK workers face £2,000 hit to real wages as severe inflationary pressure as recession risk looms - PwC UK Economic Outlook

• UK workers face average £2000 cut to real wages by end of 2022, while inflation could peak at a five-decade high of 17% by middle of 2023, based on market implied paths of energy prices in early September, but could peak at 10-13% if energy bills are frozen

• PwC forecasts the UK is likely to enter a recession as early as this year, with economic growth expected to slow down markedly in the next two years averaging between -1.3% to 0.2% in 2023 and between -0.3% to 0.6% in 2024

• UK economy missing out on potential £71.6bn annual output growth through regional productivity imbalances 

UK workers are facing a £2000 hit to their real wages by the end of the year as the UK economy confronts a highly volatile and uncertain inflationary outlook, according to the latest PwC Economic Outlook.

Although the UK economy will continue to grow at a rate of between 3.1% and 3.6% in 2022 (compared to a COVID impacted 2021)  PwC has now forecast that the UK is likely to enter a recession as early as this year, followed by a period of negligible or negative growth through 2023 and 2024.

The Outlook projects that peak inflation could range from 13% to 22% in 2023, with average annual energy bills ranging from £3,400 and £6,900, depending on the outlook for volatile energy prices and the size and form of anticipated government intervention. 

Assuming no government intervention directly targeting domestic energy prices and assuming natural gas prices follow their market implied paths as at the beginning of September, headline inflation could peak at 17% in the first half of 2023. If the government chooses to freeze energy bills, however, inflation could peak at 10-13%.

Nick Forrest, UK Economics Consulting Leader at PwC says,

“It is now likely that the UK will enter recession this year, although the path of natural gas prices and degree of government support will influence the potential size and scale of a downturn. Businesses and consumers could face two ominous milestones in the months ahead: a potential five-decade high in the inflation rate, and the largest fall in real wages since records began. We are already seeing a deteriorating outlook for consumer sentiment and business expenditure. 

“Yet many uncertainties remain around the future of global energy supply, as well as the scale and form of government support measures, which will determine the inflationary and growth outlook ahead.

“Inflation forecasts have changed rapidly in recent weeks, driven predominantly by the market price of natural gas. Until gas markets regain stability the outlook for inflation will continue to be hard to predict. This will be a challenging environment for businesses to plan, mitigate and adapt.”  

“Nonetheless, there are profound social and economic challenges ahead for businesses and individuals. We can therefore expect a renewed focus on areas to boost productivity across the UK and deliver substantial economic growth in the long-term.”

Growth outlook highly dependent on energy prices 

The Economic Outlook has prepared two possible scenarios reflecting geopolitical and economic uncertainty:. 

• “Mild winter” scenario, in which there is recovery of some supply of Russian natural gas exports, a reduction in gas prices to their September 2022 starting level, and where the UK government provides considerable support in response to the cost of living crisis.

• “Harsh winter” scenario, in which the supply of Russian natural gas exports to Europe remain highly disrupted, with gas prices remaining around their recent high point, and where the UK government’s support is more considerable than our mild winter scenario but less able to mitigate the adverse impact of high gas prices. Demand management reduces energy usage particularly by large industrials.

The UK is likely to report growth of between 3.6% in the “mild winter” scenario and 3.1% in the “harsh winter” scenario by the end of 2022, followed by two years of slow, or even negative, real GDP growth. PwC’s expectation is that year-on-year changes in economic output will range between -1.3% to 0.2% in 2023 and between -0.3% to 0.6% in 2024 under our “harsh winter” and “mild winter” scenarios respectively.

The Economic Outlook highlights imbalances across UK regions. London is likely to report above-average output growth of between 3.9% and 4.4% alongside the East of England (3.2%-3.7%), while the South East will record close to par (3-3.5%). 

All other regions are expected to under-peform the national average, particularly Yorkshire and The Humber (2.5-3%), Wales (2.4-2.9%) and the North East (2.1-2.6%) due to a higher reliance on low-productivity sectors such as retail and wholesale which are more exposed to cost pressures.

UK could gain £71.6bn through solving regional productivity gap

This edition of the Economic Outlook investigates the regional productivity gap, which measures Gross Value Added (GVA) differences in output per hour for each worker across the UK’s 12 regions.

The Outlook has found that if all regions improved productivity in their respective industries to at least the national industrial median, this could potentially add as much as £71.6bn to the total UK output per year, estimated to be around 3.4% of total GDP in 2023.

Northern Ireland could potentially benefit the most from improving within-industry productivity. The country could see an extra 16% increase in their regional GVA by closing this gap, while the North East and Yorkshire and the Humber each could potentially raise their regional GVA by 7%-9%.

Hoa Duong, PwC senior economist says:

“The UK has consistently lagged behind other advanced economies when it comes to productivity, and currently sits 4th among the G7. Yet what these findings highlight is the extent to which this is a regional and sectoral issue which drives a national problem.

“This regional polarisation is driven by imbalances between skills, workforce demographics and regional income. While the policy solutions will be specific to each region, there is a potentially substantial gain to UK GDP from closing this productivity gap, alongside the macro-level conversation about how to boost economic growth at the national level.”