Covid variant, China invasion of Taiwan and more inflation: What shocks will 2023 bring?

A new Covid-19 variant that escapes vaccines is among the biggest risks threatening to sharpen the UK recession, City economists surveyed by City PM suspect.

Asked what wildcard trends could spring up to hit the economy this year, experts warned another deadly strain of the virus spreading is one of the biggest headwinds that would magnify Britain’s downturn.

“In an extreme case some renewed lockdowns may be needed,” Sandra Horsfield, economist at fund manager Investec, said, although she highlighted vaccines could be tweaked quickly to minimise disruption.

Paul Dales, chief UK economist at consultancy Capital Economics, agreed, pinpointing China dismantling its tough zero-Covid policy as a possible trigger sparking another infection surge.

“There is a whole host of global risks. They include another wave of Covid-19, perhaps coming from China,” he said, adding supply chain disruption may resurface soon due to the recent uptick in cases in the country.

Sticky inflation forcing the Bank of England to hike interest rates even further and leave them there for longer would deepen what is already expected to be an at least year-long UK recession.

Markets think governor Andrew Bailey and co will send borrowing costs to a peak of just under five per cent this year, but those bets will shift upwards if inflation hangs around at a higher level than expected.

Both the Bank and Office for Budget Responsibility think it is on track to halve at the end of 2023, still leaving it above the Bank’s two per cent target.

Analysts said the price surge would be a permanent fixture of 2023 if energy costs stay high, workers do not return to the UK jobs market or a global trade war erupts should China invade Taiwan.

“A tit-for-tat trade war could harm the UK economy, prolong supply chain disruptions and with that, inflationary pressure,” Horsfield said.

Inflation climbed to a peak of 11.1 per cent last year and while it has likely passed its peak, it is expected to stay elevated through this year.

However, a shock upward price bump would “heighten the cost of living crisis and prolong the recession further,” Frédérique Carrier, head of investment strategy at RBC Wealth Management, said.

Don’t worry, there are some positives…

On the flip side, if inflation drops rapidly, the country would exit any recession relatively quickly.

“Inflation falling much faster than expected… could mean the economy performs better,” Dean Turner, chief eurozone and UK economist at UBS Wealth Management, said.

“Energy prices collaps[ing], reducing inflation and boosting consumer demand and growth” would engineer a “milder than feared” slump, Brian Hilliard, chief UK economist at Societe Generale, said.

Despite businesses being spiked by a six percentage point corporation tax hike and the end of the 130 per cent investment tax relief in April, the around 500,000 workers who have dropped out of the workforce could pave the way for a shock investment boom.

“The ultra-tight jobs market may yet spur some firms to look at investment in technology and equipment to mitigate against problems finding workers,” James Smith, developed market economist at ING, said.

A deal on the Northern Ireland protocol could also thaw post-Brexit trade talks between London and Brussels, Horsfield and Turner said. 

Horsfield noted an agreement would open a route to allowing Canada firms to service European banks, brokers and insurers. The UK and EU have yet to recognise each others’ financial services regulatory regime since the Brexit transition period ended two years ago.