- New EY ITEM Club forecast downgrades UK GDP growth projections to 6.9% for 2021 and 5.6% for 2022, but 2021 economic growth still expected to be the fastest since 1941.
- Decreased forecasts prompted by higher and more sustained inflation, energy price rises and supply chain disruption.
- Boost from reopening the economy post-lockdowns is now over, but the EY ITEM Club says there are grounds for economic optimism going into 2022.
The EY ITEM Club has downgraded its projections for UK GDP growth in its new Autumn Forecast, published today. Growth of 6.9% is now expected in 2021 (down from 7.6% in July’s Summer Forecast), while 5.6% growth is predicted in 2022 (down from 6.5%).
Despite the downgrades, the UK economy is still expected to grow at the fastest rate since 1941 in 2021, and 2022 growth is expected to be the fastest since 1988. The economy is forecast to regain its pre-pandemic size in the first quarter of 2022.
The downward revisions reflect a combination of higher and more sustained inflation, recent rises in energy prices, and intensifying supply chain disruption – although the strength of the labour market, high levels of household savings, and healthy business balance sheets remain causes for optimism.
Martin Beck, the chief economic advisor to the EY ITEM Club, says: “With the boost from reopening the economy now largely passed, the UK was always expected to enter a tougher phase of the recovery. Record growth is still forecast, but there are persistent headwinds as we approach the end of the year: pandemic-related policy support is being withdrawn, supply chain disruption and shortages have been more severe than expected, and the scope for catch-up growth has been run down.
“Despite these challenges, the UK economy has made some significant progress in regaining pandemic-related losses and the recovery is far from out of steam. Looking at the big picture, the economy has recovered much faster than was expected at the start of this year. Clear grounds for economic optimism remain too. While not every household has been able to save more over the last year or so, the build-up of household savings means consumers are in a good position overall. Meanwhile, the labour market is healthy and businesses have built up robust balance sheets. Long-term economic scarring from the pandemic is likely to be minimal.”
The EY ITEM Club forecasts growth to slow to 2.3% in 2023 before settling at 1.8% in 2024 and 2025.
Inflation set to be higher for longer, but ‘stagflation’ unlikely
The EY ITEM Club has revised its inflation forecast upwards, largely due to rising fuel and energy prices. Inflation is now expected to peak at close to 5% early next year, up from the 3.5% anticipated in July. Inflation is expected to remain above 3% until the second half of 2022.
Consumer spending – previously expected to grow 4.8% in 2021 and 7.4% in 2022 – is now forecast to grow 3.9% this year and 6.8% in 2022.
Martin Beck says: “Although inflation looks like it’ll peak higher – and stay higher for longer – than first anticipated, it doesn’t look like this will tip into ‘stagflation’, the combination of sluggish growth and persistent high inflation. The inflationary landscape will probably contribute to real household incomes falling around the turn of the year, slowing the rebound in consumer spending and decelerating the strong recovery seen earlier in 2021.
“However, the elevated price pressures still look like being a time-limited problem, while the £170bn-plus of extra savings households have built up in the last eighteen months should help prop up consumer spending.”
With concerns mounting over above-target inflation, the EY ITEM Club thinks the Monetary Policy Committee is likely to vote to increase the Bank Rate to 0.25% next February, followed by a further rise to 0.5% in August, but with subsequent increases not occurring until early 2023. At that point, the Bank Rate will be back to the level it was just before the pandemic began.
The success of the furlough scheme puts the labour market in a strong position
The EY ITEM Club’s forecast highlights the considerable strength of the UK labour market, with the unemployment rate now expected to rise modestly to 4.6% in early 2022 before starting to fall from the second quarter onwards. July’s forecast anticipated a post-furlough unemployment rate peak of 5.1% in the second half of 2021.
The Government’s furlough scheme seems to have made a real difference to the labour market, with the latest data from the Office for National Statistics suggesting that, as of late October, 87% of furloughed employees had returned to work. While the EY ITEM Club believes it’s too soon to fully assess the impact of the scheme’s closure, the initial verdict is that the policy overall has successfully prevented some of the long-term economic damage that high unemployment would have brought about.
As a measure of the furlough scheme’s ultimate success, the EY ITEM Club’s 2020 Summer Forecast, published in the early months of the furlough scheme, expected unemployment to peak at 9.0% by late 2020. In practice, unemployment eventually peaked at 5.2% in the fourth quarter of 2020.
Business investment has been slow to recover, but a revival still looks possible
The EY ITEM Club expects a strong rebound in business investment in 2022, with 13.8% growth forecast. This follows an expected 1.2% contraction this year, with the EY ITEM Club noting that business investment in the third quarter was still 12% below pre-pandemic levels – next year’s rebound largely represents ‘catch-up’ growth.
Positively, however, businesses have matched households in accumulating significant cash reserves: non-financial companies’ bank deposits earlier this year were almost £110bn higher than they would have been had pre-pandemic trends continued. This cash stockpile is equivalent to 5% of GDP, or six months’ worth of business investment.
Hywel Ball, EY’s UK Chair, says: “The stage is set for a more positive 2022 for business investment, and a significant acceleration is expected. The economic recovery, the incentive to invest offered by April’s ‘super-deduction’, and structural changes prompted by COVID-19 should all help business investment bounce back.
“Whether businesses do respond to these factors with increased investment is a significant risk in this forecast. The factors are all there, but some businesses might exercise restraint if uncertainty persists. 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.”
Among the other risks considered in the forecast are consumers opting to hold onto accumulated savings, continued supply chain disruptions, and the reimposition of pandemic-related restrictions should case numbers worsen. Conversely, a better-than-expected public health situation over the winter could boost consumer confidence. The resolution of supply chain problems could see inflation fall back faster than predicted too.