The household spending squeeze is a bigger challenge – one likely to prompt government action
A significant obstacle to growth in 2022 is the squeeze on households’ spending power. Unless the Government acts to mitigate them, energy bills could rise by close to 50% in April. Combined with higher oil prices and firms passing on rising input costs, this could see Consumer Price Index (CPI) inflation hit just over 7% in April, the highest since 1992 and far outpacing pay growth. April will also see personal taxes rise.
To help avert what’s been characterised as a looming ‘cost of living catastrophe’, we expect the Government to announce targeted support to help low-income households with energy costs, combined with more universal action via removing VAT and/or cutting green levies. However, a delay to April’s rise in National Insurance Contributions (NICs) now appears unlikely.
A brightening outlook for inflation in the second half of 2022
While anxiety over inflation is likely to grow in early 2022, it should start to ease in the second half of the year. Energy prices levelling off even at their current high level would eventually push down the annual inflation rate. A global relaxation of COVID-19 restrictions should see consumer spending shift back from goods to services, rebalancing demand and supply. Over-ordering by some manufacturers and retailers during the pandemic to guard against shortages could turn into a glut of inventories as spending patterns return to normal, putting further downward pressure on prices.
While our inflation view means a fall in average real pay in 2022, we don’t think that cost of living pressures will derail the economic recovery. Consumer spending should be bolstered by the easing of public concerns over COVID-19, particularly the fear of continued lockdowns, together with a strong labour market and households’ large pile of unplanned savings. Also, surveys of investment intentions suggest that a meaningful recovery in business investment may finally be in sight, aided by the ‘super-deduction’ tax incentive.
Post-Brexit trade patterns confound expectations
A year on from the end of the Brexit transition period, shifts in goods trade between the UK and EU have surprised most commentators. Trade with the EU has fallen by around 20% compared with that with non-EU countries. But the fall has been driven by lower imports from the EU, with limited evidence that the value of UK exports to the EU has yet been affected by Brexit. This is despite the fact that the UK didn’t impose new customs checks on goods imports from the EU until the start of this year, while UK exporters to the EU have faced these requirements since 1 January 2021.
While the UK’s exports to the EU have not collapsed, they might now be lower than if the UK had stayed in the EU. The reality is that an across-the-board ‘Brexit effect’ on UK-EU trade is not apparent in the latest numbers. That said, there does appear to have been a drag on UK exports in sectors where EU trade barriers are particularly high, such as agri-food. Meanwhile, data on UK services trade also points to a degree of refocusing from EU to non-EU markets.
