4 minute read 7 Feb 2022
EY Lorries from above

How the UK’s economic recovery can overcome the current headwinds

Authors
Hywel Ball

EY UK Chair and UK&I Managing Partner, Ernst & Young LLP

UK Chair and UK&I Managing Partner. Leading our 17,000 people in the UK. FTSE 100 audit partner. Father of three and Welsh rugby fan.

Peter Arnold

EY UK Chief Economist

A passionate leader and trusted advisor. Over 20 years of experience in economic policy, regulation and competition. Optimising client strategies through the use of analytics and economic analysis.

Contributors
4 minute read 7 Feb 2022
Related topics Growth COVID-19 Finance Workforce

Despite Omicron and the squeeze on household spending, EY ITEM Club predicts that the UK remains set for robust growth.

In brief
  • EY ITEM Club predicts GDP growth of 4.9% for the UK in 2022, down from its Autumn forecast of 5.6% – and well below the 7.3% now estimated for 2021.
  • The slower growth reflects the impacts of Omicron, rising inflation and financial challenges for households – including increased energy prices and NICs.
  • From mid-2022 activity should strengthen due to declining concerns over the pandemic, a buoyant jobs market and household savings built up in lockdowns. 

The economic drag from Omicron at the start of this year and the squeeze on households’ spending from higher inflation have caused the EY ITEM Club to downgrade its projection for UK GDP growth in 2022, to 4.9% from 5.6% in our November forecast. But this forecast remains higher than the consensus in the market, reflecting our view that the economy will still benefit from some powerful tailwinds. These include a buoyant jobs market, a rebound in business investment, and – probably most important of all – an uptick in sentiment as fears of COVID-19 fade.

GDP growth in 2021 exceeded expectations – and Omicron’s economic impact looks short-lived

The economy’s rebound in 2021 turned out far stronger than most expected. Output exceeded its pre-pandemic level before the end of the year, putting the UK among the G7’s fastest-growing economies. We now estimate that UK GDP grew by 7.3% in 2021, up from the 6.8% we projected in November. 

Less positively, the rapid spread of Omicron appears to have depressed mobility and spending on social activities around the turn of the year, weakening the launchpad for growth in 2022. However, with infections falling since early January and social distancing restrictions now lifted, the economic damage should prove modest.

Expected UK GDP growth for 2022

4.9%

Slightly down from our previous forecast of 5.6%

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. 

Summary

Omicron and the effects of inflation on household spending have temporarily dampened UK growth. But there are still grounds for optimism. The strength of the economy’s rebound in 2021 ultimately exceeded expectations. With Omicron’s economic impact beginning to subside, and the Government expected to cushion the effects of higher energy prices on hard-pressed households, activity should pick up in the latter half of this year. The drivers will include; the return of consumer spending on services as fears of further lockdowns fade, and a long-awaited recovery in business investment.

About this article

Authors
Hywel Ball

EY UK Chair and UK&I Managing Partner, Ernst & Young LLP

UK Chair and UK&I Managing Partner. Leading our 17,000 people in the UK. FTSE 100 audit partner. Father of three and Welsh rugby fan.

Peter Arnold

EY UK Chief Economist

A passionate leader and trusted advisor. Over 20 years of experience in economic policy, regulation and competition. Optimising client strategies through the use of analytics and economic analysis.

Contributors
Related topics Growth COVID-19 Finance Workforce