UK inflation will fall in 2023 but energy bills and taxes will rise as house prices drop. Happy new year

War in Europe. Political turmoil. A stagnant economy. Soaring energy bills. The highest inflation rate in more than four decades. Higher interest rates. That was the story of 2022. Truly, the year just gone was – in the words of the late Queen – an annus horribilis.

So 2023 will have to go some to match its predecessor for drama. The bookies would, for example, give you relatively long odds on it being another year of three prime ministers and four chancellors of the exchequer.

Less dramatic does not mean life is going to get any easier. On the contrary, interest rates and taxes are going up, and government support for energy bills is being scaled back. Price increases will still comfortably outstrip earnings growth. The economy will probably do a little better than some of the gloomier forecasters expect – but that’s not saying much. The likelihood is that 2023 will be a lot like 2022, at least for the first half of the year.

Clearly, recent history means another black swan event – something major that should have been predictable but still catches people unawares – cannot be ruled out. It is also entirely possible that some of the risks that have been identified will materialise. Russia might resort to nuclear weapons in its war with Ukraine. China might decide to invade Taiwan. If so, all the forecasts being made for the coming year would be hastily revised.

Interest rates will peak at a lower level than financial markets currently expect

But on the (admittedly heroic) assumption that there will be no 2023 equivalent of 2020’s pandemic or 2021’s supply chain bottlenecks, here’s how the economy might pan out in 2023. First, though, a health warning: the tendency of big, unexpected stuff to happen makes economic forecasting a mug’s game. What follows is almost certain to be wrong.

Prediction number one: interest rates will peak at a lower level than financial markets currently expect.

There’s not a great deal of good news currently but one hopeful sign is that inflation pressure is easing. The global factors pushing up the cost of living have gone into reverse in recent months. Wholesale gas prices are down more than 50% on last summer’s peak, while UK motorists are benefiting from a drop in the cost of crude oil.

Inflation will fall further in early 2023 as last year’s sharp price increases are not repeated, and that will allow central banks to limit future rate rises. That’s just as well because the world’s three biggest economies are all going to struggle in the months ahead. There is no obvious candidate for a locomotive for the global economy in 2023, and further aggressive moves by the leading central banks will mean recessions will be longer and deeper.

The Bank of England looks set to push UK official borrowing costs to 4% in February, making it 10 successive increases since December 2021. After that, though, it may decide to wait and see what happens.

Prediction number two: the UK will be in recession for most of the year but it will be relatively shallow.

The Bank of England looks on course to push UK official borrowing costs to 4% in February. Photograph: Amer Ghazzal/Rex/Shutterstock

Back in November, the Bank of England predicted that an already contracting economy would continue to weaken throughout 2023 and only resume growing in 2024. That forecast, however, was predicated on a much higher path of interest rates (a hangover from Liz Truss’s short-lived premiership) than currently looks likely. Given the pressures on household budgets from higher inflation, it is surprising the economy held up as well as it did in the second half of 2022, perhaps supported by people running down excess savings built up when spending opportunities were limited during the coronavirus pandemic. While there is obviously a risk that the economy will suddenly take a marked turn for the worse, the relative strength of the labour market means the peak-to-trough drop in output may be limited to 1.5-2%, a much less dramatic decline than the near 6% contraction in the global financial crisis.

Prediction number three: although the recession will be relatively mild by historic standards, it won’t feel like it.

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The Resolution Foundation thinktank has helpfully provided a list of the nasties that will face households in the months ahead. Average energy bills will rise by £900 a year as government support is reduced; the typical family will see taxes go up by £700 a year; about 2 million households will move on to more expensive mortgages costing the average fixed-rate homeowner £3,000 a year; and wages will again fail to keep pace with prices.

Put all that together and living standards will fall by 3.8% in 2023, an even bigger drop than in 2022.

Prediction four: there will be a sharp drop in house prices.

Britain’s housing market is a key reason why Threadneedle Street is likely to be wary about raising interest rates too aggressively. Prices rose to absurd levels in 2020 and continued to increase until a combination of higher interest rates and unaffordability led to the start of an inevitable correction. The Nationwide building society reported on Friday that prices had fallen for four months in a row, the first time this has happened since the global financial crisis of 2008 – and this process is far from over. It is not a question of whether house prices will fall in 2023 but by how much.

Prediction number five: economic recovery will come too late to save the Conservatives from defeat in 2024.

The economy is going to get worse before it gets better. Falling living standards and lower house prices mean little chance of a feelgood factor any time soon. Rishi Sunak has stabilised the markets after the Truss experiment but no more than that. A long period of Tory rule is coming to an end.