Deutsche Bank: Risks of UK Recession Now Underestimated by the Consensus

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The consensus was too gloomy on the UK's economic prospects entering 2023, but one investment bank now accuses economists of being too benign on the prospects of a recession later in the year.

Deutsche Bank has downgraded its growth forecasts for the UK, while underlining concerns about inflation and recession risks as various factors weigh.

These include higher interest rates, persistent inflation, a global growth slowdown, and delayed monetary policy tightening, will likely weigh on the UK economy in the coming years.

"We expect UK growth to just about remain in positive territory this year, expanding by a meagre 0.3%," says Sanjay Raja, Senior European Economist at Deutsche Bank. "But higher rates, inflation persistence, a global growth slowdown, and lags in monetary policy tightening will likely drag growth down over the next two years."

Deutsche Bank has adjusted its growth projections for 2024 and 2025, now expecting growth rates of 0.4% and 1.1%, respectively, down from the previous estimates.

Raja points out that higher rate expectations, stubborn inflation, and weaker global growth expectations will act as drags on the UK economy.

The effects of higher rates in the mortgage market are expected to gradually impact household disposable incomes and business investment, while trade activity may decline due to a weaker growth outlook in the US and Eurozone.

The research also highlights concerns about recession risks. Raja suggests that economic models may have overstated the resilience of the economy, and the consensus may be too optimistic about the potential for a downturn.

"Recession risks remain elevated in our view, and we think the consensus is too benign on the risks of a protracted slowdown," says Raja.

Despite the risks, central banks, including the Bank of England (BoE), are committed to achieving their inflation targets by raising interest rates, even if it carries the risk of a recession.

In terms of inflation, Deutsche Bank research indicates that the UK faces an inflation problem, with domestic inflationary pressures remaining high.

While headline inflation is expected to decrease gradually throughout the year, core inflation and food prices remain stubbornly elevated. Raja anticipates that CPI will land around 5% year-on-year in 2023, with a slow descent to the target rate by late 2024.

Regarding monetary policy, Deutsche Bank expects the Bank of England's Bank Rate to reach 5.25% by late Q3-2023. The research suggests that services inflation and wage growth will remain resilient until around H2-2023, and rate cuts are anticipated to commence only from Q2-2024. Raja emphasizes a "higher for longer" era, indicating that interest rates are expected to remain above neutral territory until at least 2026.

Deutsche Bank's research underscores the challenges and risks facing the UK economy, including slower growth, elevated inflation, and the careful calibration of monetary policy by the Bank of England. As the economic landscape evolves, market participants will closely monitor developments to gauge the impact on the UK's economic trajectory.