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UK Economics Chart Book

UK Economics Chart Book

Weaker economy yet to dent price expectations

The weaker economic outlook triggered by the surge in CPI inflation to a 30-year high of 7.0% in March has yet to put a dent in businesses own expectations for their selling prices. The Bank of England’s Decision Maker Panel survey found that in April businesses thought their sales revenues over the next year would increase by slightly less than they did in March. But despite that, they thought they would be able to raise their selling prices at a faster pace. The Bank of England will probably continue to raise interest rates until weaker economic activity starts to reduce businesses’ expectations for their own selling prices. We think that will happen later than most expect, which explains why we think the Bank will raise interest rates from 1.00% now to 3.00% next year. Markets Drop-In (11th May, 10:00 EDT/15:00 BST): We’re discussing our Q2 Outlook reports and what they say about the potential performance of bonds, equities and FX rates as inflation peaks in a special 20-minute briefing on Wednesday. Register now.

10 May 2022

UK Economics Chart Book

The influence of the war on the UK economy

The UK is not as exposed to the economic consequences of the war in Ukraine as the rest of Europe. Even so, in response to the surge in global commodity prices caused by the war we have dramatically revised up our inflation forecasts and modestly revised down our GDP growth forecasts. We now think CPI inflation will rise from 5.5% in January to a peak of 8.3% in April and that it will stay above 6.0% for all of this year and above 3.0% for most of next year. And we now think GDP will grow by 3.5% this year (4.0% previously) and by 2.2% next year (3.0% previously).  We suspect that the Bank of England is amply worried that the rise in actual inflation will keep feeding into higher price expectations to raise interest rates a few more times, with the next move from 0.50% to 0.75% on 17th But the risks to our forecast that interest rates will rise to 2.00% next year lie on the downside.

9 March 2022

UK Economics Chart Book

Household incomes taking a big hit

We estimate that the leap in utility prices and hike in taxes on 1st April will reduce real household disposable incomes over the next two years by a cumulative £80bn. The resulting 2.0% decline in real incomes in 2022 will be the largest on record. Even so, we expect that a surge in inflation from 5.4% in December to a peak of 7.5% in April and the risk that inflation expectations remain high will prompt the Bank of England to put aside its concerns over the weakening economic outlook and raise interest rates from the current 0.50% to a peak of 2.00% next year.

10 February 2022
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UK Economics Chart Book

Omicron may weaken activity but lift price pressures

While the emergence of the Omicron COVID-19 variant has increased the downside risks to our GDP forecasts, it has arguably increased the upside risks to our CPI inflation forecasts. The transmissibility, severity and capacity for Omicron to escape vaccines are still unknown. But if Omicron leads the government to close non-essential retail, hospitality venues and schools, we think GDP would fall by something like 3%. As has been in the case in previous lockdowns, that would boost demand for goods relative to demand for services, which may keep goods inflation higher for longer. And as long as the Chancellor revived the furlough scheme, any easing in wage pressures may only be temporary. That suggests the Bank of England will still raise interest rates from 0.10%, although it has become even more uncertain whether lift-off will happen at the policy meeting on 16th December or early next year.

UK Economics Chart Book

Inflation on the launchpad

We’ve been warning for a while that CPI inflation would rise further than most people expect and have recently pushed our own forecast even higher. We now think CPI inflation will rise from 3.1% in September to 4.0% in October and to almost 5.0% in April 2022. The RPI measure of inflation may reach 7%. This surge will mainly be driven by some big leaps in utility prices and the influence of previous rises in global costs. But while the prospect of inflation staying higher for longer may prompt the Bank of England to raise interest rates from 0.10% in December, higher inflation would also reduce the real spending power of households and firms. We still expect inflation to come back down to earth by the end of next year, which underpins our view that the Bank won’t raise interest rates far next year. Indeed, our forecast that rates will reach 0.50% by end-2022 is well below the 1.00% priced into money markets.

UK Economics Chart Book

Shortages stifling activity and boosting inflation

The broadening of the recent product and labour shortages appears to be holding back activity and adding to the upward pressure on inflation. The risk is twofold. First, these shortages may prevent GDP from returning to its pre-pandemic peak until next year. After all, the rise in the share of manufacturers reporting labour shortages is consistent with manufacturing output falling by 5%. Second, they could mean that inflation jumps by more than the rise from 2.0% in July to 4.5% in November we already expect. We think most of the shortages will be temporary. That means inflation will probably fall back to 2.0% by late 2022 and the Bank of England may not raise interest rates until 2023. But if the shortages last longer, inflation may stay higher for longer and the Bank may pull the interest rate trigger next year.

UK Economics Chart Book

Recovery becoming more tepid

With a whopping 1.0 million people on average having been asked by the NHS App or Test & Trace system to self-isolate in July, the “pingdemic” is likely to have stifled the economic recovery in recent months. In July, our Capital Economics BICS Indicator suggests that GDP did not rise much. But new virus cases have fallen substantially since mid-July and there are signs that the full vaccination of 75% of all adults has weakened the link between COVID-19 cases and hospitalisations. So we still think the economy will make good headway in Q3 and that monthly GDP will return to its pre-virus February 2020 level in October. However, it’s possible that virus cases start to climb again, which at some point could prompt the government to become worried about hospital capacity and respond by reimposing restrictions. That remains the biggest downside risk to our economic forecasts.

UK Economics Chart Book

Inflation risks rising

The risks to our forecast that CPI inflation will rise from 1.5% in April to a peak of 2.6% in November before dropping back in 2022 are increasingly on the upside. Rises in shipping costs and global agricultural commodity prices as well as shortages of semiconductors and labour could all conspire to push CPI inflation higher this year and keep it above 2% next year. At the moment, though, we think that the lingering effects of last year’s collapse in output will prompt many firms to absorb the bulk of higher costs in their margins and to limit pay rather than pass them on to consumers via much higher prices. This “spare capacity” effect explains why we think core inflation will stay below 2% until late in 2023.

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