4 minute read 26 Jul 2021
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Why the UK economy is growing at its fastest pace in 80 years

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

UK&I Partner, Economic Advisory, Ernst & Young LLP

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.

4 minute read 26 Jul 2021
Related topics Growth COVID-19 Workforce Finance

EY ITEM Club upgrades its forecast for the UK economy as COVID-19 restrictions lift and vaccine roll-out continues.

In brief
  • EY ITEM Club predicts GDP growth of 7.6% this year, the fastest growth since 1941. 6.5% growth is expected in 2022.
  • The expectations of a bounce-back in consumer spending and supportive macroeconomic policy contributes to the largely positive economic outlook.
  • However, questions remain over inflation prospects, predicted to reach 3.5% by Q4 of 2021; how consumers will tap into pandemic savings remains to be seen.

The recent surge in COVID-19 infections means that declaring victory over the virus is still some way off. But vaccinations and the removal of most virus-related restrictions have reduced the impacts of the pandemic on economic activity. Consequently with strong support from fiscal and monetary stimulus and the pool of involuntary savings built up by UK households, the EY ITEM Club has upgraded its forecast, predicting GDP growth of 7.6% this year and 6.5% in 2022 (previously 5%).

Positive growth expected as lockdown is lifted

The highlight of the EY ITEM Club’s Summer Forecast is a stronger performance from GDP this year and next. Forecast GDP growth in 2021 would be the fastest since 1941, and output is predicted to regain its pre-COVID-19 level by the end of this year. While the unemployment rate may creep up in the second half of this year, we expect the Labour Force Survey (LFS) rate to peak at only a little above 5%.

The big development since our last forecast in April has been the reopening of previously shuttered parts of the services sector. Following a smaller than expected lockdown-driven fall in GDP in Q1, a relaxation of social distancing restrictions has triggered a strong, consumer-led, recovery. The shortfall in GDP relative to pre-pandemic levels narrowed from 8% in February to a little over 3% in May.

Granted, the pace of growth has cooled as the summer has progressed. This has been coupled with a rise in the number of COVID-19 infections, related to the more transmissible 'Delta' variant, which caused a four-week delay to the planned removal of most remaining domestic restrictions in England. However, the postponement of 'Freedom Day' is unlikely to have thrown the economic recovery off track to any great degree.

Expected UK GDP growth

7.6%

Fastest growth since 1941

The UK is in a strong position to perform well

Thanks to the furlough scheme and businesses adapting to life under lockdown, the jobs market is emerging from the crisis in a better state than expected. Although unemployment is higher than just before COVID-19 struck, the increase in joblessness has been much smaller than most forecasters feared and a shadow of what was seen during past economic downturns, despite a comparatively huge blow to output.

Now that people are returning to working, shopping and socialising, the UK is well-placed to achieve a strong bounce-back in growth. With the economy shrinking so much compared to most other advanced economies, it means there’s more lost ground to make up. UK consumers are particularly big spenders on consumer services, which should magnify the economic boost from life returning to normal. Additionally, the UK’s approach to measuring public sector output will create positive gains for GDP. Moreover, a deficit in tourism with the rest of the world means growth should, perversely, gain from continued obstacles to international travel.

Another powerful impetus to growth should come from households’ savings dropping back from the very elevated levels reached during the pandemic. Involuntary saving contributed to 2020 seeing the biggest rise in households’ net worth since 2016. A return to the typical, pre-pandemic, household saving ratio would be enough to fuel a strong rebound in consumer spending. Households going further and spending some of the £200b of excess savings built up since early 2020 would make that rebound even stronger.

A virtuous circle of positivity among businesses about rising consumer spending could boost firms’ confidence and output. The fuel to sustain this – strong household and corporate balance sheets, and supportive fiscal and monetary policies – is there.
Hywel Ball
EY UK Chair and UK&I Managing Partner, Ernst & Young LLP

Support from macroeconomic policy will also underpin a strong expansion this year and next. Fiscal policy remains in loosening mode, while the Chancellor may be able to rein back planned future tax rises and spending cuts, if, as we think, the economy recovers more strongly than the Office for Budget Responsibility (OBR) expects. Meanwhile, the Monetary Policy Committee (MPC) is predicted to keep the official interest rate at its current record low of 0.1% until late 2022.

Inflation and pandemic restrictions still cast a shadow over positive recovery

Technical factors, combined with supply disruption connected to the reopening of economies globally, will push inflation up during the rest of this year and into 2022. We think the Consumer Price Inflation measure will peak at around 3.5%. But other influences, including the stronger pound, will keep a lid on price pressures. And the ingredients needed to support sustained high inflation appear lacking.

Household savings are concentrated among higher-income households, while higher unemployment and inflation will weigh on real income growth. Household incomes are expected to rise just 1% in real terms this year.
Martin Beck,
Senior Economic Advisor to the EY ITEM Club

The recovery will not be uniform. Spending in some areas, such as household goods, which benefited from diverted spending during lockdowns, will fall back. With regards to general consumer sentiment, the end of remaining restrictions could fuel an unexpectedly strong and positive surge in sentiment. Adversely, a sufficiently large rise in infections risks seeing restrictions return. Consumers might also choose to keep savings levels up. Even a temporary period of high inflation could trigger a hawkish shift from the MPC, causing financial conditions to tighten. Finally, the departure of foreign-born workers during the pandemic threatens to weigh on the economy’s capacity to grow. Should increased production be required due to higher demands, rising prices and inflationary bottlenecks could occur.

While the economy has proven increasingly resilient through lockdowns, the future pattern of the pandemic and any renewed pandemic-related restrictions will have a significant bearing on whether this positive forecast is achieved.

Summary

With the lifting of COVID-19 restrictions across the country, and the vaccine roll-out continuing to progress, the growth prospects of the UK economy have improved beyond previous predictions. The economy is now expected to return to its pre-pandemic peak by the end of 2021 – two quarters sooner than expected in April.

However, a rebound in inflation offers one reason for caution about the outlook.  Inflation is expected to reach 3.5% by the end of 2021.

Consumer spending is crucial to economic recovery, and the risk of a return of restrictions is still an unknown factor.

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

UK&I Partner, Economic Advisory, Ernst & Young LLP

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.

Related topics Growth COVID-19 Workforce Finance