Why the recovery remains strong – but is being slowed by headwinds

However, these growth rates are still strong in historical terms, and the recovery is far from running out of steam. Household finances are at their heathiest on record and many businesses are sitting on large cash piles. What’s more, it appears that tax policy will be less of a drag on the economy than previously expected, and the jobs market has rebounded.

The UK has made further headway in its recovery from the pandemic  

Since the EY ITEM Club’s last forecast in July, the economy has clawed back more of the losses triggered by COVID-19. UK GDP in September was only 0.6% below its pre-pandemic level in February 2020, a rebound bolstered by the removal of most remaining virus restrictions over the summer. However, the momentum of the recovery has now slowed, as the scope for catch-up growth has narrowed and bottlenecks and shortages have seen supply fail to keep pace with rising demand.

The revival in output has been reflected in the labour market. The official unemployment rate is within half a percentage point of its pre-COVID-19 level, and job vacancies and hiring have been running at record highs. That said, employment is still significantly below early 2020. It’s still too soon to assess the effects of the furlough scheme’s closure in September, although early indications suggest it had only a modest effect on unemployment.  

The buoyant jobs market – which is emerging remarkably unscathed from the crisis – will support what has been strong momentum in consumer spending. But obstacles to growth are building. Given rising fuel and energy prices, the EY ITEM Club predicts CPI inflation will now peak at close to 5% early in 2022 and remain above 3% until the second half of the year. This could compound the squeeze on consumers from recent cuts in benefits and next April’s hike in personal taxes. 

Reasons for optimism: strong household finances and rising business investment intentions

More positively, households have continued to accumulate savings, and their financial strength could help to counter these headwinds. With house prices rising, households’ net wealth has reached its highest on record in relation to income. But with savings and assets skewed towards the better-off, lower-income households are still likely to have to cut discretionary spending to meet the rising costs of essentials.

Turning to businesses, business investment has lagged behind the recovery in consumer spending. However, firms’ mostly healthy financial position should support spending on fixed assets, and recent surveys have reported more robust investment intentions. Many large companies have paid down bank debt during the pandemic and the corporate sector has increased its cash holdings, which, as of late summer, were at almost £110bn – equivalent to 5% of GDP or six months’ business investment.