Russia’s invasion of Ukraine is likely to have a large effect on the UK economy. The scale of this effect is likely to be in the mind of Chancellor of the Exchequer Rishi Sunak when he releases his Spring Forecast Statement on 23 March 2022.
We have run our estimated impact of the invasion and associated actions on our economic model UKMOD with the base forecast as Cebr’s latest released forecasts published on 3 March 2022. We have assumed commodity prices reflect the initial movements in the spot market and follow through to prices actually paid. Worryingly, this is not a ‘worst case’ scenario – spot prices are now higher than we assumed and Russia’s threat to stop supplying oil could well push the price of oil well above the level assumed.
Based on our scenario analysis which assumes a high transmission of sanctions to global commodity prices and UK inflation, we estimate that GDP growth this year will be halved – down from a previously forecast 4.2% in 2022 to 1.9%. And growth in 2023 is reduced from 2.0% to 0.0%. The reduction in real GDP in 2022 is £51.4 billion; that in 2023 is £42.5 billion. Cumulatively this is a reduction in GDP of more than £90 billion per annum.
The main channels for these impacts are the rising cost of living, a reduction in consumption and reduced exports because of sanctions on Russia.
The effect of higher commodity prices reduces the level of disposable income by 1.9% in 2022 and by 2.1% in 2023. As a result we estimate that disposable incomes will fall in 2022 by 4.8% with a further fall of 1.4% in 2023. The fall in 2022 is the largest since records started in 1955[1].
The forecast fall in living standards this year is an estimated £71 billion – which amounts to £2,553 per household. The part of it due to invasion of Ukraine is about half – £35 billion (£1,259 per household) – but there is a further reduction from this source in 2023 of £29 billion (£1,043 per household).
The combined effects of sanctions and slower world trade growth reduce export growth in 2022 by 2.1% and by 0.5% in 2023. Export growth was previously predicted to be 3.0% this year and 0.4% next so these combined impacts more or less wipe out the predicted export growth.
Inflation by Q4 2022 is likely to be 4.1 percentage points higher than we previously forecast.
Our earlier forecasts had quarterly CPI inflation peaking at 7.3% in Q2 2022 and then falling back quite sharply as the inflationary momentum disappeared. We now expect quarterly CPI inflation to hit 8.7% in Q2 and to remain above 7% until Q1 2023. The scale of these effects is such that government would find it hard to resist action. When the price of gas rose sharply earlier in the year (partly a result of Russian action) the government moved to reduce the impact on the cost of living. And the MPC would surely need to take the likely movement to recession into account when setting interest rate policy (this is in fact assumed in the analysis which assumes a lower path for Bank Rate reaching 1.25% in 2024 rather than the base forecast of 2%). So the Chancellor is likely to be under further pressure to put the economy on a semi wartime setting on 23 March.
[1] The fall in consumption in the UK during WW2 was 17.3% between 1938 and 1943 according to calculations based on research by S.N. Broadberry and W.P. Howlett. The fall in consumption is a better measure of wartime austerity than real disposable incomes since part of the fall was through forced savings through lack of availability of goods.