4 minute read 22 Nov 2021
office-lit-up-late-at-night-item-club-autumn-forecast

Why the recovery remains strong – but is being slowed by 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 22 Nov 2021
Related topics COVID-19 Growth Workforce

EY ITEM Club downgrades its UK growth forecast amid inflationary pressures, supply-chain disruptions and a looming rise in interest rates.

In brief
  • EY ITEM Club predicts GDP growth of 6.9% this year and 5.6% in 2022 – down from its previous forecasts of 7.6% and 6.5%.
  • While growth remains buoyant, factors including rising inflation, supply constraints and the prospect of higher interest rates are slowing the recovery.
  • But strong financial reserves built up by households during lockdowns and a revival in business investment will help to offset the constraints on growth. 

With the UK economy facing a combination of headwinds – including a squeeze on living standards from higher inflation, broadening supply-chain disruption and the likelihood of an earlier-than-expected rise in interest rates - the EY ITEM Club has reduced its growth forecast for the UK. The EY ITEM Club now projects that UK GDP will grow 6.9% this year and 5.6% in 2022, down from its previous forecasts of 7.6% and 6.5% respectively.

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

Expected UK GDP growth

6.9%

Downgraded from the 7.6 predicted in the summer

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.

 

Having been through two ‘once in a lifetime’ economic shocks in just over a decade, businesses will be looking for certainty and investment support from policymakers.

Fiscal, monetary and inflationary impacts all raise uncertainties

To date, the UK recovery has been aided by very stimulative fiscal and monetary policies. While much of the COVID-19-related fiscal support has now ended, the extra public spending in October’s Budget will ease the fiscal tightening over the coming years. Meanwhile, the Monetary Policy Committee (MPC) chose not to raise interest rates in November, despite sounding increasingly hawkish. While the MPC could potentially raise rates in December, we think it will first want to assess the impact of furlough closure and will wait until February before triggering any ‘lift-off' in rates.

The MPC’s change of tone reflects the threat of rising inflation. Driven mainly by surging energy and fuel prices, inflation is set to be higher for longer than previously expected, with the CPI measure set to hit its highest in a decade. But structural factors and the likely resolution of supply problems mean we still believe the spike will be transitory.

Given that it’s 15 years since the UK last faced a sustained rise in borrowing costs, it’s unclear how the economy will respond. However, since the financial crisis, we’ve seen trends including a fall in the proportion of households with a mortgage and higher take-up of fixed-rate home loans. These shifts mean higher interest rates should have less of an effect on economic activity than in the past.

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Summary

With the UK economy continuing to rebound from the pandemic-related slowdown, GDP growth is powering ahead at rates not seen for several decades.

But with the jobs market booming and household finances in their strongest state ever, the rapid economic growth is bringing its own challenges – in the form of rising inflation and supply chains struggling to keep pace with resurgent demand. There’s also the prospect of a rise in interest rates, although probably not before February 2022.

However, while these factors may marginally constrain the UK’s post-pandemic recovery, they won’t derail it.  

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 COVID-19 Growth Workforce