Economy will shrink 2% but unemployment expected to hit 1.7m

Government debt is set to balloon £400 billion higher than previously expected, warned the fiscal watchdog as it unveiled a bleak outlook for the economy.

The Office for Budget Responsibility (OBR) said the economy is already in recession and will shrink further next year due to sky-high inflation.

It forecast that it will shrink by 2% over a lengthy recession which started earlier this year.

The OBR said squeezed incomes, higher interest rates and tumbling house prices – which it expects to drop by 9% by 2024 – are all set to contribute to a recession lasting “just over a year”.

The official forecaster downgraded previous projections the economy would grow by 1.8% in 2023 to a fall of 1.4%.

Growth expectations for the following year were also downgraded due to inflation.

It has, however, slightly upgraded the total economic growth expected this year to 4.2% from 3.8% in the March statement.

The OBR has also predicted inflation will hit an average rate of 9.1% this year and 7.4% in 2023. Previously, forecasts had indicated inflation of 4% next year.

The Bank of England has repeatedly hiked interest rates in an effort to drag down on inflation, with rates jumping to 3% earlier this month.

The OBR said higher interest rates have had a significant impact on government debt, which it said is now expected to be £400bn higher – roughly 18% of the size of UK GDP – in 2026-27 than it forecast in March.

Rate increases mean servicing government debt will double to over £120 million, which the

OBR said will make public finances “more vulnerable to future shocks”.

The cost of servicing this debt will be the highest proportion since following the Second World War.

Unemployment is also expected to jump over the next two years from 3.6% to 4.9% in the third quarter of 2024.

This would mean a 505,000 increase from 1.2 million now to a peak of 1.7m.

Chancellor Jeremy Hunt said the forecasts “confirm that our actions today help inflation to fall sharply from the middle of next year”.

“They also judge that the UK, like other countries, is now in recession,” he added.

Mr Hunt confirmed new spending reductions and tax plans are intended to secure an extra £55bn to address the UK’S fiscal hole.

The hole is the extra money needed to meet self-imposed targets to bring down the size of state debt relative to national income.

Some economists questioned the outlook from the OBR, which was largely more upbeat in the medium-term than the Bank of England’s latest economic forecasts.

Martin Beck, chief economic adviser to the EY Item Club, said: “The OBR’S forecast is potentially too downbeat.

“The OBR’S numbers are conditioned on interest rates rising to 5%, a level which the official forecaster predicts would contribute to inflation falling below zero in 2025.

“A lower rate assumption, and one consistent with the Bank of England’s 2% inflation target, would mean a better growth outlook.”