Macro – UK outlook
13 June 2022
By Henk Potts, London UK, Market Strategist EMEA
With runaway inflation, rising rates, and weakening global growth, the UK economy faces a hangover as the engines of last year’s strong recovery – buoyant consumer spending and a rampant housing market – begin to splutter. Will the authorities’ priorities be tackling inflation or engineering a soft landing?
After enjoying one of the strongest recovery rates in the developed world in 2021, the UK economy looks set to stall over the next 18 months. A combination of surging inflation, higher interest rates, tight labour markets, and the rising tax burden are expected to hit growth prospects.
UK inflation jumped to 9% in April1, with the headline consumer price index (CPI) hitting its highest level since 1982. Price pressures continue to emanate from transport, where petrol prices increased to a record £1.618 a litre; the average increase on motor fuels over the past year rose to 31.4%. Hospitality was the other major upward contributor, with the reopening trade continuing to push up prices for accommodation and the cost of alcoholic drinks in restaurants and pubs. Elsewhere, prices strengthened in food, housing, and household goods and services.
Price pressures are more pronounced and longer-lasting than previously projected. Updated energy expectations suggest that Ofgem price caps will be considerably higher than previously modelled. We also expect restaurant and accommodation inflation to remain robust, as lockdown restrictions disappear. By contrast, there are signs that second hand car prices continued to level off in April.
The Bank of England (BoE) now forecasts that the 40% increase in the regulatory price cap due later this year will drive CPI inflation to 10% in October2. While double-digit inflation maybe a short-lived spike, we expect inflation to stay above the 2% target over the forecast horizon, possibly even through 2025.
At the Monetary Policy Committee’s (MPC) May meeting, the BoE increased interest rates by 25 basis points (bp), taking the bank rate up to 1%. This hike was considered to be the last increase from a policy normalisation perspective. That said, the MPC has become far more concerned about the level and persistence of inflation, second-round effects on wages, and rising inflation expectations, therefore we expect further policy increases in the coming months.
We forecast 25bp hikes at both the June and August rate-setting meetings, putting the bank rate at 1.5% in the summer, despite the faltering growth prospects.
The UK tax burden is set to rise to its highest levels in eight decades over the next couple of years (see chart). The government has enacted, or announced, hikes to corporation tax, increases in national insurance contributions, and frozen income tax thresholds. From next April, corporation tax will rise to 25% from 19%. The freezing of the threshold for the higher rate of income tax will also push the number of people paying the 40% charge to its highest level.
The overall tax burden is anticipated to rise substantially over the next four years. Tax as a percentage of gross domestic product will increase to 36% in 2026/27 from 33% in 2019/20, which would mark the highest level seen since the 1940s.
The UK’s labour market recovery from the depths of the pandemic has been extraordinary. However, the shortage of workers is now inhibiting firms’ ability to grow and risks further fuelling inflation.
The unemployment rate in the quarter to March fell to 3.7%3, the lowest recorded since 1973. The number of job vacancies rose to a new record of just below 1.3 million in March. Meanwhile, on the back of the tight employment market, growth in average total pay surged to 7% from 5.6% in February4.
We expect wage growth to remain elevated as workers demand higher salaries to offset the surge in inflation. We estimate that average weekly earnings will grow by around 5-6% this year. Although, even with this increase, real wages (adjusted for inflation) will continue to be squeezed.
The independent watchdog the Office for Budget Responsibility now forecasts a 2.2% drop in real income over the next year. This would represent the largest hit to living standards in any financial year since records began in 19565.
The squeeze in the cost of living is affecting consumer confidence and spending habits. In data that spans nearly 50 years, in May the GFK consumer confidence index plummeted to minus 40, a record low. The Office for National Statistics stated that retail sales volumes fell 1.2%6, adding to the decline seen in February. The fall was led by a reduction in spending at online retailers.
There are also signs that consumers are cutting back on travel due to the record high price of fuel at the pumps. Google mobility data, which offers a real-time snapshot of activity, shows footfall at UK retailers has flat-lined since mid-February. While much of the weakness can be attributed to the pressures on consumers’ disposable income, wealthier households seem to be switching some of their discretionary spend to travel and hospitality from goods.
The outlook for household consumption will be driven by the balance between the pent-up demand, following the easing of restrictions, and the higher cost of living. The reduction in spending is likely to be at a slower pace than we would normally assume at a time of elevated inflation, given the excess savings that were built up during the pandemic.
That said, weakening leading indicators and lower levels of confidence may encourage consumers to hold onto their savings for longer. We see private consumption growth slow to 0.7% in 2023 from 4.9% this year.
After booming in the post-pandemic world, the UK housing market continues to deliver impressive price growth, despite the stamp duty land tax reverting to its October 2021 levels. Recent data from lender Nationwide showed that house prices climbed 12.1% year-on-year in April, although that was lower than in March.
This moderating trend is expected to continue through this year, as rising mortgage rates (due to increases in the bank rate) and declining real incomes reduce momentum. Furthermore, the BoE lending survey suggests that banks are starting to tighten the availability of secured credit.
The Royal Institute of Chartered Surveyors survey in March, showed early signs of softening, with the balance between buyers’ enquires and instructions falling to levels not seen since late 2020. The survey also showed that measures of excess demand in the rental sector have weakened as well. The easing of these indicators would be consistent with flat house price growth by the end of the year.
Nevertheless, in the medium term we continue to believe that the UK housing market will be underpinned by structural supply and demand imbalances (for instance, inventories remain close to their lows), robust labour markets, and less demand from international buyers (particularly if sterling remains weak).
With the economic recovery phase continuing to play out at the start year, UK growth is still expected to be a very respectable 3.5% in 2022. However, the headline figure masks the deterioration forecast in the latter half of the year and into 2023. The accumulation of substantial headwinds has encouraged the central bank to forecast that the UK economy will contract by 0.25% next year, which is more pessimistic than our forecast of 1% growth (see table), but the risks are very much skewed to the downside.
|
2021 |
2022F |
2023F |
|
|---|---|---|---|
|
GDP growth |
7.4 |
3.5 |
1 |
|
CPI inflation |
2.6 |
7.9 |
4.1 |
|
Unemployment rate |
4.5 |
4 |
4.4 |
|
Gross public debt (% of GDP) |
94.7 |
92.2 |
92 |
|
Private consumption |
6.2 |
4.3 |
0.7 |
Source: Barclays Research, Barclays Private Bank, May 2022
This month we take a look at the major trends at play in the financial markets and the implications of surging inflation, central bank rate tightening, and slowing economic growth prospects. We also look at how private markets might be needed to bolster diversification, and what investors can do to limit the effect of what may continue to be a volatile end to the year.
