- New EY ITEM Club forecast says UK GDP grew 7.3% in 2021, up from the 6.8% predicted in its previous forecast.
- However, the UK growth forecast for 2022 has been downgraded to 4.9% from 5.6%.
- Omicron variant and a squeeze on households’ spending power are the key factors in downgrade – but Omicron impact is expected to be limited and temporary.
- The EY ITEM Club says inflation could reach almost 7% in the spring – its highest level since 1992. The Bank of England is expected to raise Bank Rate to 1% by the end of this year.
The bounce back in the UK economy was stronger than expected last year, but the EY ITEM Club’s Winter Forecast has nevertheless downgraded its projections for UK GDP growth for 2022. The EY ITEM Club believes that UK GDP grew 7.3% in 2021, up from the 6.8% predicted in its previous forecast. Growth of 4.9% is now expected in 2022, down from 5.6% in November’s Autumn Forecast.
The EY ITEM Club’s revisions are prompted by the Omicron variant’s impact on activity at the start of 2022 and the prospect of a significant squeeze on households’ spending power from high inflation.
In the latest forecast, inflation is expected to reach almost 7% this spring – significantly higher than the 5% peak expected in November’s Autumn Forecast. This is expected to prompt the Bank of England to raise Bank Rate to 1% by the end of the year.
However, the EY ITEM Club remains optimistic about the prospects for the economy and believes the UK is likely to benefit from a robust jobs market, a rebound in business investment, and a boost to sentiment as another COVID-19 wave recedes.
The EY ITEM Club forecasts growth to reach 2.7% in 2023, up from 2.3% in the previous forecast, with the economy making up for the Omicron variant’s impact on 2022 growth. GDP growth is then expected to settle at 1.8% in 2024 and 2025.
Hywel Ball, EY’s UK chair, says: “The forecast shows that the economy’s bounce back in 2021 was stronger-than-expected and Omicron’s economic impact is likely to be temporary and limited. While the economy and UK businesses may have a softer launch pad for growth this year, they will still benefit from a number of tailwinds in 2022 and 2023.
“But blowing in the opposite direction will be a squeeze on household spending power which is expected to be a bigger headwind for the economy than the Omicron variant. Inflation is set to reach its highest level in thirty years by the spring and will be well ahead of pay growth.
“Although the latest forecast says that the economic scarring from the pandemic is likely to be minimal, policymakers still face the challenge of how they help support households through the forthcoming squeeze on their finances and give companies the confidence needed to unlock business investment. The push towards Net Zero certainly creates an opportunity for investment growth.”
Inflation puts pressure on consumer spending – although low unemployment and high savings will support the consumer recovery
Consumer spending is now on course to grow 5.7% in 2022 and 5.6% in 2023, according to the EY ITEM Club, with the forecast for 2022 downgraded from the 6.8% growth expected in the autumn report.
But while 2022 looks like it may be the year when average worker pay falls in real terms for the first time since 2017, the EY ITEM Club says that a consumer spending recovery will be supported by a natural bounce back from the lifting of restrictions, Omicron hesitancy receding, historically high levels of household savings, and low unemployment.
The EY ITEM Club expects the unemployment rate to remain stable at its end-2021 rate of 4.1% until the middle of 2022. It is then forecast to decline to just under 4% by the end of the year. This would be historically low – only two years since 1971 have seen a jobless rate of 4% or less.
Martin Beck, chief economic advisor to the EY ITEM Club, says: “Despite an inflationary squeeze, there is still plenty of support for consumer spending, not least the unwinding of the high levels of savings accumulated by many households over the course of the pandemic.
“However, not all households will have built up savings in the pandemic and those that haven’t are also more likely to be affected by the impact of the higher energy costs. Households will benefit from targeted government help on energy costs, but the measures announced will not fully offset the squeeze on household incomes. As a result, this year is likely to see an increase in polarisation between the economic experience of high- and low-income households.”
The EY ITEM Club expects inflation to fall back to the Bank of England’s two per cent target in the first half of 2023 as energy prices stabilise and global imbalances between demand and supply ease – although the unprecedented nature of the pandemic means the forecast notes that it is difficult to make this call with any degree of certainty.
Business investment acceleration expected in 2022
The EY ITEM Club expects business investment to rise 12.7% in 2022, after eking out projected growth of less than 1% in 2021. An assumption that the worst of the pandemic is over, the UK ‘super deduction’ investment incentive, as well as a need to need to adapt to worker shortages, Net Zero targets and the pandemic-accelerated digitalisation of the economy should all encourage businesses to invest.
The forecast also notes that, as of November 2021, the pandemic has helped corporate sector ‘excess’ cash holdings to reach £115bn or 5% of GDP.
Hywel Ball says: “The UK is on track for a more positive 2022 when it comes to business investment, and a meaningful recovery is finally in sight. Businesses and the economy have learned how to adapt to the shock of the pandemic over the last two years and the incentive to invest should be supported by an easing of COVID-19 concerns and the ‘super-deduction’.
“However, a significant risk in the forecast is the extent to which businesses respond to these incentives. If COVID-19 uncertainty re-emerges, some businesses might continue to curb their investment spending. After going through the economic shock caused by the pandemic, businesses will be looking for certainty and investment support from policymakers.
“At present, there is more certainty around challenges to business investment: the planned rise in the corporation tax rate and end to the super-deduction in 2023 could both see investment fall back significantly.”
Too soon to draw ‘Brexit Effect’ conclusions
The EY ITEM Club forecast also includes an initial analysis of the economic impact of the UK’s departure from the EU.
Martin Beck comments: “There is no obvious across-the-board ‘Brexit effect’ in the data, although there have been some unexpected shifts in the trade in goods between the UK and EU over the last year. UK trade with the EU has fallen by about 20%, but this has been driven by lower imports from the EU rather a fall in UK exports. That said, while exports to the EU haven’t fallen significantly, they may be lower than they would have been had the UK remained in the bloc, and there have been clear drags in some sectors such as agri-food. Meanwhile, data on UK services trade also points to some reorientation from EU to non-EU markets.”
COVID-19, savings, inflation and interest rates are some of the key forecast uncertainties
The EY ITEM Club’s report outlines a number of key risks to its forecast, including the future path of the pandemic, inflation, interest rates, and households’ appetite to save. The EY ITEM Club notes that developments in COVID-19 could affect consumer spending and business investment for good or ill, while the path for inflation will be influenced by government and Bank of England interventions. Meanwhile, relatively modest fluctuations in savings rates could mean the difference between a consumer spending ‘boom’ and a more stagflationary picture for the economy.