UK GDP growth
The UK economy could reach its pre-COVID level by the end of the year. We expect the UK economy to end the year with an annual GDP growth rate of between 7.0% and 7.1%. This is largely similar to our previous forecasts made in July.
The UK economic outlook will be determined by four key factors, which we base our two scenarios around:
Development of the COVID pandemic
The continued pace of mass vaccination and boosters against COVID-19 in the UK and the risk of a rise in cases as a result of increased indoor mixing combined with waning immunity.
Headline GDP growth in 2022 could be between 4.5% and 5.1% but this is largely driven by base effects. The annual growth figures in the first half of 2022 are expected to be skewed as the economy comes off its low base due to the national lockdown in early 2021. Core underlying growth will continue to be relatively modest, continuing the low-growth trend we have seen this year driven by the normalisation of economic activity.
We then anticipate GDP growth to slow down in 2023 as the economy returns to its pre-pandemic trend. By the end of 2022, the UK economy is likely to be roughly 1% to 2% above the pre-COVID levels. From 2023 onwards, the pace of growth is projected to slow down further as base effects fall out of the annual figures. Under our two scenarios, we expect growth could range between 1.3% and 1.8% in 2023.
Source: PwC analysis
We expect the uneven impact of the pandemic to continue as the recovery is increasingly polarised across sectors, regions and households. Lower income households are squeezed, especially those struggling to retrain and reenter the workforce post furlough, while higher income households have the potential to spend. Growth in the hospitality sector is projected to continue accelerating in a fully opened economy while output from other sectors, like construction and manufacturing, is expected to be moderated by workforce shortages, supply bottlenecks, and weakening demand and business confidence. At the regional level, the pandemic has resulted in the most severe regional disparity in output in the past 50 years, with the West Midlands, and the South East underperforming due to their heavy reliance on manufacturing, retail and wholesale, while Northern Ireland is the only region where economic growth has exceeded both expectations and the pre-crisis levels. We expect this polarisation to be one of the key drivers behind the UK’s low-growth prospects, and may be one of the core factors affecting growth over the medium-to-long term.
Source: ONS, Scottish government, NISRA, PwC analysis. Note: Darker shades indicate lower-than-expected economic performance, and the lighter shades show better-than-expected performance. Values show the extent to which changes in regional output deviated from expectations based on their industry structure.
UK CPI inflation
Inflation is likely to reach its highest level for three decades in Q2 2022, before returning gradually back to target. Ofgem’s price cap review, combined with the scheduled reversal of the VAT cuts for hospitality and tourism, is expected to create a perfect storm that pushes headline inflation rates to around 5%-6% in Q2 2022. However, we expect inflation to gradually fall back to target over the next 1-2 years as the impact of these two factors fade, supply bottlenecks ease, and base effects dissipate.
Energy and fuel prices are expected to drive most of the rapid rise in inflation. Despite only accounting for around 6% of the CPI basket, we expect energy and fuel to account for around a third of the decade-high Q2 2022 headline inflation rate. As in historical cases, we expect that high energy prices will soon start to moderate, and this will help to bring headline inflation rates down from their Q2 2022 peak. If not, we could see the spillover effect of higher energy prices spreading into the wider economy, which could prolong high rates of headline inflation.
Higher inflation could be sustained for longer if inflation expectations become de-anchored. If people become accustomed to inflation exceeding the Bank’s target, this can lead to businesses setting higher prices and workers demanding higher wages. At present, short-term inflation expectations have risen sharply, but medium-term expectations have remained relatively well anchored. However, there is the risk that households will uplift their expectations once they see their utility and shopping bills rising sharply in the coming months. To date, the economic data doesn’t suggest that a wage-inflation spiral is developing.
Source: ONS, PwC analysis
UK labour market
Emerging evidence suggests the end of the furlough scheme has not set back the labour market recovery. Various indicators and surveys suggest that a significant majority of the 1.1 million workers still on furlough at the end of September remain in employment.
However, it will take some months to understand the full impact of the end of furlough. This is because furloughed employees that have been made redundant will still be included in the payroll data while they serve out their notice periods.
This means the short-term outlook for the labour market is cautiously optimistic. While we do not expect a notable increase in the UK unemployment rate over the coming months, it is 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.
But there will inevitably be a period of adjustment over the coming months. The path of labour market recovery is unlikely to be smooth, as skills mismatches and changing worker preferences create frictions. We are already seeing these frictions play out in recruitment challenges and worker shortages. We therefore expect to see a period of adjustment over the coming months as people retrain and move into new sectors.
Source: ONS, PwC analysis