- Despite a "pingdemic"-related pause in July, the U.K. economic recovery remains on track. We forecast GDP growth of 6.9% this year and 5.2% in 2022.
- Current labor shortages are limited to specific and strategic jobs, creating mostly temporary downstream supply issues, and exacerbated by the unavailability of EU workers who left during the pandemic.
- Inflationary pressures are building, and we have raised our near-term inflation outlook to 3.4% for Q4 this year (from 2.7% in our previous forecast). However, we see inflation gradually returning to 2% by the end of 2022.
- Despite the Bank of England's recent more hawkish signaling, we believe it will not raise interest rates or move on QE before late 2023.
The U.K. economic recovery paused in July, largely due to one-off factors, such as the "pingdemic", when the National Health Service's tracking app notified users they had been in close contact with someone who had tested positive for COVID-19 and needed to isolate. This left swaths of workers staying at home and created disruptions in production and distribution. But, according to our estimates, activity has since increased again, and the recovery remains on track. We continue to forecast GDP growth of just under 7% this year and 5.2% in 2022. At this rate, the U.K. should regain pre-pandemic levels of activity by early 2022-- one quarter later than the eurozone, owing to the much more significant contraction experienced by the U.K. in the second quarter (Q2) of last year.
The rapid vaccination of a large share of the population allowed the near-full reopening of the economy from July. Subsequently, COVID-19 cases started to rise again, and have continued to increase until very recently. However, hospitalizations have largely decoupled from the case load, and deaths have remained very low at 0.4% per case as of mid-September, down from above 3% at the beginning of the year. This makes the reintroduction of restrictions unlikely for now and is good news for the ongoing recovery. Even if a major new wave materializes in the winter, and the government reintroduced more stringent restrictions, they would likely be more targeted than in the past, in our view. Importantly, the economy is now also much better adapted to the pandemic than a year ago, and we would expect far less damage from any fresh restrictions.
The recovery will be driven predominantly by consumers catching up to pre-pandemic spending levels. However, consumers have so far remained rather cautious. They are still saving a significantly larger share of their income than prior to the pandemic, even as the economy has reopened. The full force of this extra spending will be felt only in 2022, when the savings rate is set to come down to around 7%, from the 9.5% that we estimate currently.
Where Are The Workers?
The strength of the recovery is also visible in the labor market, with strong employment gains in the past few months, and further, although more moderate, gains ahead. Vacancies exceeded the one million mark in August, with about 250,000 more vacancies than was normal in pre-pandemic times. Moreover, employers are now complaining about staff shortages, especially in some key sectors, such as transportation.
However, the notion that there be widespread staff shortages is misplaced, in our view, because there is really no lack of workers in general. At the beginning of August there were still about one million workers on furlough. Having not been recalled to their workplaces full time, even as the recovery made good headway, many of them are likely to join the 1.6 million unemployed at the end of September when the furlough scheme ends. Some of the workers who had withdrawn from the labor force during the pandemic should also start coming back from the fourth quarter.
But even in some of the sectors that are widely reported to be experiencing staff shortages, such as transport, the data and anecdotal evidence suggest shortages are limited to specific and strategic jobs in certain sectors, where employers struggle to match jobs and workers with the right skills. The widely cited shortage of lorry drivers is one example. One explanation for the current shortage is that many EU nationals with such skills left the U.K. during the pandemic--some estimates put this figure at around 200,000.
It will take time and money to incentivize U.K. resident workers to upskill and fill these jobs, previously often taken by EU nationals, and pandemic restrictions have already delayed training. Some localized staff shortages may persist for longer unless authorities decide to tweak immigration rules. These have made new hiring of EU workers more difficult since the beginning of the year, especially in lower-paid jobs, as new rules impose minimum levels of pay. Some of the greatest shares of vacancies are in such sectors, including hotels, bars, and restaurants. The situation is exacerbated by the fast pace of the recovery, which has left hiring in some key sectors unable to keep up. Where jobs are not predominantly dependent on labor supply from the EU with specific skills, shortages should gradually dissipate as the pace of the recovery slows.
The Specter Of Supply Shortages
The rapid recovery in global demand in combination with structural factors has led to supply shortages of certain goods used as inputs in production, with semiconductors perhaps the most prominent example. The U.K. economy is also suffering from a lack of supplies to the construction industry, where activity has been declining partly for this reason over the past few months. However, given the U.K. focus on services, it is suffering far less, for example, than Germany with its sizable car and industrial goods manufacturing sector. Indeed, for the U.K., production is being limited less by material shortages than by downstream distribution issues that create bottlenecks, caused by the staff shortages in strategic jobs, especially in logistics.
On top of the challenges posed first by the pandemic and then reopening, the U.K. economy must deal with the effects from its new trade arrangement with the EU following Brexit. Vastly more red tape has lowered trade volumes in both directions, even though the implementation of the new rules on the U.K. side has yet to be phased in fully. Had the government not decided to postpone the next phase of the implementation until January next year, this would have exacerbated current supply issues. And while the economy will still feel the effect of the full implementation next year, by then it will likely be better prepared and many of the pandemic-related supply issues should be resolved, a process which has already started.
The Specter Of High Inflation
Consumer price inflation (CPI) made its largest leap in recent history in August, jumping to 3.2% from just 2% a month earlier. However, this was largely driven by the price-lowering effect of the government's "Eat Out to Help Out" restaurant subsidies introduced in the summer of 2020. More generally, on the conventional year-on-year measure, prices are currently rising from low levels in 2020. These so-called base effects are of a statistical nature and, as such, will be temporary. Moreover, the development of prices since the start of the pandemic in 2020 shows that average inflation has been just 2%. And even if inflation were to reach 4% in December--which would be in line with the Bank of England's expectations--annualized price growth would still average just 2.5%, more benign than the high 3.2% for August suggests.
However, there are further pressures in the pipeline. Wholesale electricity and gas prices have already risen sharply on the back of increases in global energy prices, and retail prices are set to follow suit once the regulator Ofgem's new higher price caps come into effect on Oct. 1, which will then allow retailers to increase tariffs. This will affect the CPI figure directly via the energy component in it.
Higher prices of energy, transportation, and materials have also already entered the supply chain, which will ultimately also affect CPI. In August, producer input prices were 11% higher than 12 months ago, and producer output prices had risen by 6% over the same period. Some of the input price pressures have yet to show up in output prices, and, initially exacerbated by some persistence in supply and staff shortages, will then likely be passed on to consumers. This is a rather slow process and will underpin inflation well into next year.
Wage growth has also been significant in recent months, with regular pay growth of 5.9% on average across the whole economy. But, just like consumer prices, base effects played an important role here, too, as well as compositional effects from different speeds of hiring across individual sectors. Indeed, average annual wage growth of 4.1% since just before the pandemic, albeit above average, looks much more benign.
The core question is, of course, whether higher inflation will be transient or longer lasting. In our view, it will be mostly transient. Global pressures on supply should ease as the recovery of economies across the globe matures, the demand-push abates, and supply chains are repaired or adjusted. Most of the inflationary pressures at play currently and in the near term, especially from higher global energy prices, should also ease next year. We see little reason why price increases should be permanently higher. Even in some crucial sectors, such as semiconductors, the main supply shortages look to have peaked already. This all means that inflation is set to ease from mid next year, although it could run well above the 2% target for longer. The inflation rate could run higher for longer than we currently forecast if the effects of the full implementation from next year of more stringent post-Brexit customs checks exceed those already factored into our forecast.
To account for recently increased price pressures, we have revised our forecast for inflation upward. We now expect inflation of 3.4% on average in the final quarter of this year, compared with 2.7% in our previous forecast. The impact on GDP growth is very limited, in our view, because higher wage growth will offset inflation's impact on the purchasing power of households, whose spending remains underpinned by a strong catch-up momentum.
BoE Steady Until 2023, Despite More Hawkish Signaling
Unlike other major central banks, the Bank of England (BoE) has recently provided clear guidance about its policy stance regarding quantitative easing (QE). It lowered its guidance for the level of the policy rate above which it would start passively reducing its balance sheet (by not reinvesting redemptions) to 0.5%, from 1% earlier. It did the same with the rate for active balance-sheet reduction (active selling of bonds), lowering it to 1.0% from 1.5% earlier. Moreover, it confirmed that it has no intention of extending QE once the current target of balance-sheet expansion is achieved by the end of the year.
All this clearly makes for more hawkish signaling. Yet, it implies little in terms of policy changes. Indeed, contrary to more fickle market expectations about monetary tightening, we continue to believe the BoE will not move on interest rates before the end of 2023, and will then hike only gradually, unless strong signs emerge that higher inflation is here to stay. This means especially that, according to the BoE's own guidance, not even passive tightening of QE should be started before the end of 2023, and monetary policy should remain as supportive as it is now well beyond the main phase of the recovery.
|U.K. Economic Forecasts|
|CPI inflation (Q4)||1.4||0.6||3.4||2.0||1.8||1.8|
|10y government bond||0.88||0.32||0.69||1.05||1.54||1.70|
|Exchange rate (EUR per GBP)||1.14||1.13||1.16||1.16||1.16||1.17|
|Exchange rate (USD per GBP)||1.28||1.28||1.39||1.40||1.41||1.41|
|Source: ONS, BoE, S&P Global Ratings.|
The views expressed in this report are the independent opinions of S&P Global Ratings' economics group, which is separate from but provides forecasts and other input to S&P Global Ratings' analysts. S&P Global Ratings' analysts use these views in determining and assigning credit ratings in ratings committees, which exercise analytical judgment in accordance with S&P Global Ratings' publicly available methodologies.
This report does not constitute a rating action.
|Senior Economist:||Boris S Glass, London + 44 20 7176 8420;|
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