Over the last few days, we have seen several economists waxing lyrical about prospects for the UK economy in the short to medium-term. While many people are reluctant to get “carried away” until the Bank of England joins the party, last week’s MPC minutes demonstrate an encouraging improvement in confidence.
Prospects for the UK economy
There is no doubt that the UK government’s Covid-19 vaccination program has been more successful than even Boris Johnson could have hoped. As a growing number of the UK population have had or stand ready to receive their second vaccination injection, there has been a significant upswing in both business and consumer confidence. This has prompted a serious rethink by the Bank of England. However, there are two ways to look at the change in economic forecasts announced today.
The MPC expect increased gross domestic product (GDP) growth in 2021, upgraded from 5% to 7.25%. If this growth forecast materialises, this would be the fastest pace of economic growth in the UK since the Second World War. Many people believe that the UK government’s roadmap to freedom has played a massive role in allowing businesses and consumers to begin to look to the future. Even accusations of sleaze and corruption seem unable to penetrate the hard shell of optimism surrounding the UK Conservative government.
The only downside is that growth expectations for 2022 have been reduced from 7.25% to 5.75%. While this puts the change in forecasts in perspective, this is still an overall net increase in forecast economic growth. Indeed, it is worth mentioning that the UK is forecast to have one of the strongest economies in the developed world in the short to medium term.
Unemployment in the UK
There are perfectly justifiable concerns that UK unemployment will rise significantly when the furlough scheme finally ends in September 2021. However, it was interesting to see the Bank of England slash the projected peak jobless rate from 7.75% down to 5.5%. This is a considerable reduction over a relatively short space of time, reflecting both the furlough scheme extension and expected economic growth.
Over the next few months, as the economy moves back towards a degree of normality, there will be a significant shortfall in supply over demand. This is something that the Bank of England has been expecting, hence the increase in the short-term economic growth forecasts. Quite simply, businesses had been unwilling or unable to invest in their short-term capacity because of trading restrictions. Many of these restrictions will be lifted in the coming weeks and months, giving rise to an increase in confidence.
While the UK government has invested billions of pounds into the furlough scheme, we can only estimate how many jobs have been secured at this moment in time. While there are slight variations on the lifting of restrictions across the UK, generally, the UK is coming out of lockdown together.
Inflation in the UK
When looking at UK inflation, it is easy to get caught up in monthly fluctuations, which have been exacerbated due to the pandemic. It is better to take a longer view and look at the potential issues which might impact inflation in the medium term. We know that the MPC has maintained its long-term inflation target at 2%. Using the CPI measurement, the annual rate to March 2021 came in at 1%, compared to 0.7% in February and 0.9% in January. As the short-term imbalance favouring demand over supply continues, we are likely to see a further increase in inflation.
Taking a longer-term view, the MPC believe that inflation will peak at 2.4% in the final three months of 2021, due in the main to an expected increase in energy prices. Thankfully, this spike in the inflation rate is likely to be short-lived, falling back to the target level of 2% in early 2022. As you would expect, the MPC has cautioned against “getting carried away” with short to medium-term prospects for the UK economy, while keeping a close watch on potential growth in the longer-term.
UK interest rates
No one was surprised to learn of the unanimous decision to keep UK interest rates at 0.1%. Interestingly, as a basis for short to medium-term economic and inflation forecasts, the MPC highlighted an expected increase in base rates in the first half of 2023. While still some way out, and things can change, this is the first time the Bank of England has even broached the subject of a rise in base rates for some months.
We also saw one member of the MPC vote to reduce the Bank of England’s quantitative easing (QE) programme, currently held at £895 billion. As a consequence of the expected improvement in the economy, this member voted for a £50 billion reduction in QE funding. Again, this is a very positive development, although a recent slowing of the QE programme apparently had nothing to do with growth rate upgrades.
We only need to look to India to see how the fight against Covid-19 continues. At this moment in time, India is reporting upwards of 400,000 new cases of Covid-19 each day. Oxygen needed to treat patients is in short supply, there appears to be a limited number of vaccines, and there are serious concerns the worst is yet to come. So, while the UK vaccination programme is going better than anybody could have expected, there is still the challenge of new variants emerging.
If we also look at the US, there have been improvements in Covid-19 vaccinations, and it appears to be “under control”. That said, India and the US are still lagging behind the UK regarding economic activity and the lifting of restrictions. There is always a danger that a drag on the Indian and US economies, not to mention problems in the European Union, could reduce worldwide economic growth, which would impact UK growth.
Steering the good ship Blighty
When the MPC decide to hike short-term economic forecasts, it is time to sit up and listen. You can detect from the MPC minutes a growing confidence the UK economy is over the worst. While nobody believes the pandemic is over, the vaccination programme has undoubtedly instilled a degree of confidence in businesses and consumers. The short-term flip-flop of 2021 and 2022 economic growth forecasts reflect a current imbalance between supply and demand, favouring demand.
There will be a flattening of the supply/demand curve in the short to medium-term. However, the MPC openly discussing an interest rate rise during the first half of 2023 does reflect growing confidence. So, as the good ship Blighty continues its journey back to recovery, there are reasons to be cheerful. However, there could still be some choppy waters ahead!