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Cautious optimism for the UK economy in 2022 but the polarised recovery continues and consumers face a ‘triple squeeze’

01 Dec 2021

  • UK output in September 2021 was just 0.6% lower than February 2020 levels
  • Regional polarisation caused by the pandemic is significantly more severe than any previous economic downturns, especially those reliant on manufacturing, retail and wholesale, having a higher number of cases or an older population
  • Analysis shows the West Midlands was hit the hardest due to reliance on manufacturing, retail and wholesale sectors
  • In contrast, impact was less visible in the East Midlands due to its greater focus on light manufacturing and its strong growing services sector
  • Households facing triple consumer squeeze over 2022/23 as inflation, higher interest rates and increased national insurance contributions bite

The UK economy continued its recovery in Q3 2021 but economic polarisation is likely to see a return to sluggish levels of growth as consumer spending is squeezed in 2022/23, according to new analysis from PwC.

UK output in September 2021 was just 0.6% lower than February 2020 levels due to a welcome acceleration in monthly growth. But sectoral data presents a stark picture of the uneven nature of the recovery, with the normalisation of everyday activity being the main driver of growth, according to the latest PwC UK Economic Outlook.

UK GDP growth is expected to remain strong in 2022, at around 4.5-5.1%, but PwC economists caution that this is primarily driven by the impact of base effects as the fall in output during the national lockdown a year ago skews the annual figures. Core underlying growth is expected to be relatively modest, marking a return to a low-growth period until at least 2023.

Jonathan Gilllham, chief economist at PwC UK, says:

“The UK economy is continuing to recover at a rapid rate, fuelled by the reopening of many sectors, but significant risks to recovery remain. There are already signs that this growth will become increasingly sluggish through 2022-3, as base effects fall out of the annual figures while consumers and sectors struggle with rising costs and supply chain bottlenecks.

“This polarisation of the economy will also be evident across sectors. For example, we expect sectors like manufacturing to experience slower growth next year of between 1% and 2%, while hospitality is expected to grow between 16% and 20% under our ‘limited’ and ‘accelerated growth’ scenarios.

“While many areas of the economy are returning to health and stability, this economic polarisation could create uneven effects and continue to act as a brake on growth in the medium term, even as some headwinds begin to clear.”

Regional polarisation a significant brake on recovery

Regional polarisation caused by the pandemic has been significantly more severe than any previous economic downturns, with the average regional disparity in Q2 2020 of 4.3 percentage points - more than double the nearest comparator of Q1 1974, the peak of the ‘winter of discontent.’ The mid-1970s and early 1980s recessions had particularly severe adverse impacts on regions that had a heavy industrial base, such as the West Midlands and the North of England. In contrast, the impact was less visible in the East Midlands due to its greater focus on light manufacturing and its strong growing services sector.

Matthew Hammond, Midlands Region Leader, PwC says:

“Our analysis shows the West Midlands was hit the hardest of all regions. This is mainly due to the regions’ reliance on manufacturing, retail and wholesale sectors, which have been hammered by supply disruptions and social distancing restrictions. The West Midlands also experienced in absolute terms one the highest rates of COVID cases and mortalities in the UK, contributing to the poorer-than-expected economic performance.”

Matthew Hammond, continues:

“The pandemic has resulted in the most severe regional disparity in output in the past 50 years, and most UK regions underperformed expectations when it comes to the speed and scale of recovery. This regional polarisation is one of the key drivers behind the UK’s sluggish recovery prospects, and may be one of the core factors affecting growth over the medium-to-long term. However, the regions’ significant growth over the past five years and long-term growth ambitions and investments in HS2, Coventry City of Culture and the Birmingham 2022 Commonwealth Games will encourage the right conditions for a recovery.

“Additionally, the path of economic growth is also dependent on the combined impact of various upside and downside factors. The upside factors include stronger than expected employment growth, where despite the furlough schemes ending in October 2021, the UK labour market shows signs of resilience. Increased household spending, as the largest component of GDP, household spending has been an important driver of the UK’s economic recovery this year. Since June 2021, full reopening of the economy has resulted in releases of pent-up consumer demand and desire to spend. Alongside this, positive but modest growth in business investment, following a year of relatively subdued business investment, is expected to contribute more strongly to GDP growth this year, albeit modestly but a desire to strengthen the balance sheets post-lockdown may continue to impact investment intentions.

“Downside factors that will impact recovery and growth include high inflation and inevitable interest rate rises, adding pressures on household spending, business costs and tax rises, which are likely to weaken household spending, and supply chain disruptions which will also drag on growth, with prolonged trade frictions (including implementation of the NI Protocol), worsened by the pandemic and rising shipping costs are expected to be a key risk to the UK economic growth in the medium term.”

Consumer splurge or consumer squeeze?

Three factors have the potential to pave the way for a consumer splurge next year: a strong labour market, combined with a large stock of excess savings, and a desire to move on from the pandemic could create the right recipe for household spending to propel growth.

Hoa Duong, economist at PwC, says:

“More people have been going out to eat, going on holiday, and going to see their GP in person - and this normalisation of everyday activity is driving growth.

“But the triple consumer splurge will likely be concentrated on higher income households, while lower income households could be hit by a triple consumer squeeze. There are three factors that have the potential to moderate this splurge, especially for lower income households. These households will feel the pinch from a combination of rising inflation, higher interest rates, and fiscal changes, especially the increase to national insurance contributions over 2022/23.”

Inflation: transitory or permanent?

Inflation could reach its highest level for three decades in Q2 2022 as the rise in the energy price cap and the reversal of the VAT cuts for hospitality and tourism create a perfect storm that is set to push headline inflation rates to around 5%-6%.

Jake Finney, economist at PwC, says,

“We expect inflation to gradually fall back to target over the next 1-2 years as the impact of the rise in the energy price cap and reversal of VAT cuts reduce, recent supply bottlenecks ease, and base effects dissipate.

“Yet there is a risk that higher inflation is sustained for longer if consumer inflation expectations become de-anchored from Bank of England’s own targets. This could become a self-reinforcing spiral as businesses set higher prices and workers demand higher wages, which will also negatively affect consumer spending.”

Cautious optimism for labour market

The short-term outlook for the labour market is cautiously optimistic. The emerging evidence points to a small overall impact of the end of the furlough scheme and the UK unemployment rate of 4.3% in September was only 0.3 percentage points higher than it was pre-COVID. A record 3.2% of workers also changed jobs in Q3 2021, which is a key sign of improving worker confidence, and there was 3.1% growth in average earnings in real terms until September 2021.

Hannah Audino, economist at PwC, says,

“Most measures of labour market health are moving in the right direction, and there are signs of increasing tightness in the labour market as many workers return to work. However, it will take some months to understand the full impact of the end of furlough due to notice periods and there are signs of friction in matching workers to vacancies as businesses are increasingly reporting recruitment challenges.It is, however, likely that there will be a rise in the inactivity rate, as workers are discouraged from entering the workforce after so long out of work. It will therefore be important for government policy to shift its focus from the unemployed to the inactive, for example through retraining and reintegration programmes.”

Ends.

Notes to editors:

PwC’s UK Economic Outlook - December 2021
 

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