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Deloitte: rising energy prices will not cause a recession

Author: ICAEW Insights

Published: 30 Mar 2022

Economists from Deloitte examine how surging energy bills are affecting different sectors, while deflating concerns about recession due to built-up household savings from the pandemic.

The accumulation of high levels of savings by consumers during the pandemic will pave the way for further growth in consumption and likely stave off recession, despite the emergence of pre-recessionary factors, a senior economist believes.

Speaking at a recent Deloitte webinar, Ian Stewart, Deloitte's chief economist in the UK, said: “The balance sheets of corporates, and particularly households, are stronger than on the eve of previous recessions. Consumers have accumulated high levels of savings during the pandemic.

“I think that will enable consumption to continue growing. And that's very important. Most rich countries' consumption is around about 60% of GDP. Unemployment is low, labour markets are very, very tight. And the problem increasingly is one of scarcity of labour, which speaks to rises in wage costs. Interest rates are going up, but if the market is right, then in the UK and the US they are likely to peak around about 2.5%, which is not an extreme level.”

Historically, most of America's recessions have been preceded by significant run-ups in the price of oil; a rise in oil prices is a harbinger of rising inflation, rising interest rates and economic dislocation, which generates recessions.

However, Deloitte doesn’t think the current rise in oil prices will lead to a recession, although the risk of stagflation – of stagnation and recession in the last month – is something that is worth keeping an eye on.

Rising interest rates are also a point of concern as inflation is likely to hit around 7-8% in Europe and North America in the next few months.

But Stewart said financial markets and economists have good reason to believe that inflation will ease next year, and that will bring relief to consumers. “All of those reasons suggest [that] this is still likely to be a year of growth in the West, albeit significantly lower than had been expected at the start of the year,” he added.

What is the central impact of rising commodity prices?

John Raven, economic advisory director at Deloitte, said that the impact of rising commodity prices on different sectors varies considerably, mainly due to the supply side through increased input costs for businesses. The impact of the cost of living crisis will also vary across different sectors.

“Some sectors – say food manufacturing or agriculture – are less exposed to the cost of living crisis, whereas more cyclical sectors such as the manufacturing of luxury goods or possibly construction will be more exposed to reductions in real spending power,” he said.

Raven added that the impact of higher costs on businesses is “cumulatively complicated” in terms of demand-and-supply dynamics. For example, a petrol station can quite easily pass on the higher costs of petrol to the consumer because they know their competitors will most likely do the same. But while drivers could react by purchasing an electric vehicle in the longer term, it would take some time for that to impact demand.

“Other sectors may be relatively less directly exposed, for example manufacturing or construction, because there will be a greater degree of potential for firms to absorb costs. It may be that firms are less able to pass through costs, and therefore in the short term at least [that will] have a more direct impact upon firms,” he said.

What does this mean for businesses?

Andrew Barroso, director in Deloitte’s economic advisory team focusing on the energy and resources sector, said businesses are having to think about how the impact on costs affects their strategy and their pricing, and he looked at what this means for businesses’ approaches to sourcing energy, in the short, medium and long term.

Short-term cost-cutting

Looking at ways in which they can reduce their energy consumption and manage energy costs is likely the only thing businesses can target in the short term.

“In some cases, companies have already started to increase their prices and pass these costs on to consumers, while others are still considering their options,” said Barroso.

Companies were increasingly thinking about where they source their energy from in terms of both suppliers and energy sources, which was resulting in some shifts in the UK market.

Medium-term planning

In the medium term, businesses are looking to adopt more permanent ways of reducing their exposure to increasing costs and more volatile energy prices. This could be by adopting new technologies, such as renewable energy, or continuing with efficiency projects to further reduce their energy consumption, Barroso said.

Long-term benefits

All the recent increases in energy prices will help people and businesses focus their attention on what they can do now, and how they can adapt in the future, to deliver on their net zero strategies.

Over the long term, this will impact how they look to decarbonise their business, including reducing reliance on fossil fuels and looking more at clean energy sources.

“The implication of this, in some ways, could be that actual planned spending and investment into green technologies and renewables could go up in the near-term – accelerating the transition to net zero,” concluded Barroso.

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