UK investors boosted by healthier economic prospects

• UK set for strong post-COVID recovery with growth set to reach 6.7% in 2021, before easing back to 4.2% in 2022 – driven by a successful vaccine rollout and increased consumer spending
• The record budget deficit is expected to keep rising as the UK government aims to spend its way out of the pandemic
• Inflation is likely to peak below 2.5% in late 2021, before dropping as base effects from last year’s comparisons unwind
• For those sitting on excess cash – interest rates are expected to stay at their historical lows of 0.1% through to the end of 2022.

A successful vaccine programme and accelerating consumer spending are driving UK growth and lifting sentiment. But with a bulging budget deficit and the risk of a vaccine-resistant virus, how long can the good times last?

The UK economy registered its worst economic performance in more than three centuries in 2020. The 9.8% contraction was worse than the slump after the first world war and considerably worse than the decline recorded in Europe and the United States.

As we have progressed through 2021, we have become more constructive around the speed and shape of the UK’s recovery. The successful vaccination programme has allowed the government to provide a road map, albeit delayed, for the reopening of the economy thereby helping to boost both sentiment and activity.

Improving public health situation

Cases in the UK peaked at the start of the year, with a seven-day average of around 59,000 new daily cases. Due to the sharp rise in cases, a third national lockdown was introduced in early January, leading to a steady reduction in cases.

At the end of May, the average had reduced to around 3,000 new daily cases despite higher testing. Hospitalisations and deaths are down 96% and 98% respectively from their January peak at the end of that month too. However, the rise in Delta variant cases since the start of June is a reminder that we can’t be complacent about authorities’ ability to eradicate the virus.

Sixty-five million vaccinations have been administered since the beginning of June, with nearly 50% of people aged 18 and over having received two doses, substantially above projections at the start of the year.

Brexit disruption dissipates

Our Outlook 2021 last November referenced the risk of a no-deal Brexit. Last minute compromises on fishing and level playing field governance paved the way for the UK and EU to successfully conclude a trade agreement. The deal guarantees tariff-free trade on most goods and creates a platform for future EU-UK cooperation on issues such as crime fighting, energy and data sharing.

The deal’s five-year review clause offers an opportunity to develop and broaden the trade agreement. The agreement therefore avoids the scenario of EU-UK trade falling back to the tariffs and quotas foreseen under basic World Trade Organisation (WTO) rules.

We should recognise that even with a trade agreement, the divorce was one of the hardest possible outcomes for the UK. As such, it resulted in significant adjustments for many businesses and supply chains. The government will need to look for progress on trade agreements beyond the EU to recover part of the shortfall.

Chancellor keeps spending

The March budget saw the UK chancellor deliver a series of measures to ensure the recovery and also offer a strategy for putting the nation’s finances back onto a sustainable path. He focused his fiscal firepower on supporting the economy, businesses and employment and extended emergency measures.

The furlough programme was lengthened until September 2021, a £5bn restart grant scheme was provided for the high street and the hospitality sector and a “super deduction”, to reduce tax bills for investments for the next two years, was introduced.

Among the revenue raising measures was the proposed lifting of the corporation tax rate to 25% from 19% in 2023 and the freezing of personal income allowances from April 2022 to April 2026.

The budget deficit is forecast to rise over the next couple of years. That said, the government appears to be committed to their 2019 manifesto pledge to leave the main revenue raisers of income tax, VAT and national insurance unchanged. The speculation surrounding the introduction of an excess profit tax or a wealth tax proved to be unfounded.

Lower peak unemployment and consumer strength

Household consumption is accelerating, reflecting the effect of the easing of coronavirus restrictions on consumer spending. April retail sales volumes surged 9.2% month on month and were 42% higher than in April 2020, which were affected by the first national lockdown. Non-food stores provided the largest contribution to sales growth and the proportion of online sales declined in all sectors as physical stores reopened.

The Bank of England estimates that consumers have accumulated more than £200bn in excess savings during the pandemic and project that up to 10% of this will be spent in the coming quarters, helping to propel growth.

At the height of the pandemic, economists feared that UK unemployment could surge to around 9%. The extension of the furlough programme and faster reopening of the key service sector allows us to reduce our forecast for peak unemployment to 5.7% in the fourth quarter (Q4).

For 2022, we predict unemployment will average 5.4%, still significantly higher than the pre-pandemic average of 3.8% in 2019.

Inflation back below target in 2022

As we have seen in other regions, year-on-year UK inflation prints have registered sharp gains. The consumer price index jumped to 2.1% in May, the highest since July 2019, primarily due to energy-related base effects and rising prices for clothing and footwear. However, there are still few signs higher producer prices are translating into higher consumer prices, with services inflation hovering around historical lows.

We anticipate that inflation will peak below 2.5% in Q4 and then ease back below 2% as base effects rescind and growth rates ease.

Low, but not negative interest rates

The prospect of negative interest rates has all but evaporated, unless the UK’s growth profile unexpectedly deteriorates dramatically. The Monetary Policy Committee is likely to maintain the status quo as the recovery plays outs. We expect rates will be held at the historically low rate of 0.1% through 2022.

Risks of an earlier rate hike?

We do not anticipate that the bank rate will rise before the end of next year. However, there are upside risks to that forecast if a significantly stronger recovery materialises and inflation is projected to be sustainably above the 2% mark. Such a scenario could be achieved by a combination of factors: consumers running down accumulated savings at a faster rate; a quicker recovery in labour markets could create wage growth; or businesses start to exert some pricing power in response to the robust demand which could stoke inflation above the target level.

Improving outlook

The bounce in household consumption, lower projected peak unemployment, as well as rising activity from the supportive fiscal package, and reduced Brexit distractions encouraged us to raise our 2021 full-year growth forecast to 6.7%. Looking forward to 2022, we project growth of 4.2%.

Source: Barclays Research, Barclays Private Bank, June 2021