UK’s growth prospects worst among top economies, OECD warns

The UK economy is set to be the worst performer in the G20 bar Russia over the next two years, the OECD said on Tuesday, underlining the lasting impact of high energy prices on Europe as a whole.

The OECD said in its latest economic forecasts that UK GDP would fall by 0.4 per cent in 2023 and rise by a mere 0.2 per cent in 2024. That would be a longer and deeper downturn even than the forecast for Germany, whose manufacturing intensive economy is particularly vulnerable to high energy prices.

In an apparent reference to Brexit, Álvaro Santos Pereira, the OECD’s acting chief economist, said the economic adjustment under way in the UK had compounded longstanding concerns about the country’s low productivity growth.

He singled out Britain’s need to forge post-Brexit commercial relations with the rest of the world, with “trade deals that you need to export and so on high on the agenda”.

The UK is already the only country in the G7 where output has not yet regained its pre-Covid levels. Britain’s Office for Budget Responsibility said last week that households were facing the steepest fall in living standards on record as the economy entered recession.

The Paris-based organisation also hit out at the UK government’s pledge to hold average household energy bills at £2,500 until April, saying the untargeted support would “increase pressures on already high inflation in the short term”, leading to higher interest rates and debt service costs.

The OECD said business sentiment was starting to recover from “a period of deterioration driven by policy uncertainty” — an allusion to the former Truss administration’s hastily reversed “mini” Budget. But it said “lingering uncertainty”, combined with higher costs of capital, would continue to weigh on business investment.

The risks to the UK’s already poor outlook were “considerable and tilted to the downside”, the OECD said. It noted in particular the risk that acute labour shortages could “force firms into a more permanent reduction in their operating capacity or push up wage inflation further”. 

More generally, the OECD said the world economy was “reeling” from the largest energy shock since the 1970s. According to its latest forecasts, growth in almost every large economy was set to be weaker next year than it had thought in June, as persistently high inflation slashed people’s spending power.

The OECD expected growth next year of just 0.5 per cent in the US and the euro area, with Germany falling into recession, and the more resilient emerging economies driving a global expansion of 2.2 per cent.

The organisation warned that the energy crisis was “here to stay”, with Europe facing even bigger risks next winter than it did now of gas shortages that could tip it into recession.

Although the OECD expected inflation to ease next year, especially in the US and Brazil, it thought consumer prices would rise by 6.8 per cent across the euro area in 2023 and 3.4 per cent in 2024.

“Fighting inflation has to be our top priority,” said Santos Pereira, arguing that central banks were “doing what they need to do” but that governments needed to scale back untargeted fiscal support that was adding to inflationary pressures.

“Inflation is definitely becoming a lot more entrenched . . . it will not come down as fast as we would like, he said, adding: “We see light at the end of the tunnel, but it’s a long tunnel.”

In line with its criticism of the UK’s energy support scheme, the OECD said France, Germany and other countries also needed to phase out measures that kept energy prices artificially low for everyone and instead offer more targeted income support for vulnerable households.

It argued it was crucial to create incentives to save gas if Europe was to guard against energy shortages and an even worse economic shock next winter.

So far, helped by mild weather, gas storage levels have remained high across the EU. The OECD was assuming that significant disruption could be avoided if energy usage remained about 10 per cent below its five-year average, but said it was not clear whether demand could be met in a typical winter.

Santos Pereira said replenishing storage capacity next year could prove more difficult if Chinese demand for LNG rebounded as Covid-19 lockdowns lifted, so that a cold winter could lead to shortages emerging. This could lead to high energy prices being much more disruptive and persistent.

“Europe would certainly be in recession this year if we had a cold winter . . . Next winter, the same could apply,” he said.