Economic growth is slowing and the end of the furlough scheme, along with rising inflation, means uncertainty ahead.
Rising energy prices and supply shortages have led to inflation climbing to its highest rate in nearly a decade. Further increases in prices are expected over the next few months, potentially leading to slower economic growth as consumers’ purchasing power erodes.
This Insight covers the latest developments in inflation, monetary policy, the labour market and GDP growth.
Inflation over 4% and rising
Inflation has risen during 2021. Strong demand from consumers for goods and higher costs for businesses are being reflected in higher prices.
Consumer prices, as measured by the Consumer Prices Index (CPI), were 4.2% higher in October 2021 than a year before. This compares to under 1% in the first few months of 2021.
One of the main sources of inflation is energy prices, with household energy tariffs increasing and petrol costs going up. Supply shortages are also putting upward pressure on prices, which is largely a global phenomenon.
In early November, the Bank of England forecast inflation to rise to 4.5% in the coming months before peaking “at around 5%” in April 2022. April is when the household energy price cap will next be changed, with a further increase expected. The last time CPI inflation was above 5%, or indeed above 4%, was in 2011.
Interest rates expected to increase
High and rising inflation has put pressure on the Bank of England to raise interest rates from their current historic low of 0.1%. An increase in interest rates raises the cost of borrowing for companies and individuals. This may lead to lower demand in the economy, easing the pressure on prices.
At its early November meeting, the Bank’s Monetary Policy Committee (MPC) voted by a margin of 7-2 to keep rates unchanged. The Bank’s Governor, Andrew Bailey, said he was “very uneasy” about current inflation rates.
Financial markets had expected the MPC to raise rates in November following, among other things, comments from the governor that the MPC “will have to act” if there’s a risk that inflation forecasts remains above target.
The MPC targets for a CPI annual inflation rate of 2% over the medium term (usually interpreted as a few years ahead). The outcome of the next MPC meeting will be published on 16 December.
The end of the furlough scheme
The MPC said it would keep a close eye on developments in the labour market ahead of its December policy meeting. In particular, it wanted to see more data on what happened to the 1.1 million people who were on the furlough scheme when it ended on 30 September. If unemployment is low, there are less people looking for jobs and employees therefore have more bargaining power, which could put upward pressure on wages and inflation.
Early evidence suggests a limited effect on the overall unemployment rate following the end of the scheme. HMRC estimates of the number of payrolled employees (so excluding the self-employed) were up by 160,000 in October, compared with September.
A survey conducted in late October by the Office for National Statistics (ONS) found that 87% of furloughed employees returned to work and 3% were made redundant following the end of the scheme. The rest had voluntarily left their jobs or are classified as ‘other’. A survey from the Resolution Foundation think tank found that 88% of workers on furlough at the end of the scheme were in work in October.
The unemployment rate of 4.3% in July to September was down from 4.7% in the previous three-month period. That compares to around 4% before the pandemic and peak rate during the pandemic of 5.2% in late 2020.
Uncertainty about the strength of the recovery
The strength of the recovery in GDP following the reopening of the economy has moderated in recent months. GDP growth of 1.3% in the third quarter followed growth of 5.5% in the second quarter.
Looking at monthly figures, GDP increased by 0.6% in September after a weak July and August. Most of this rebound came from an increase in health sector output, notably a rise in the number of GP appointments. GDP remains 0.6% below its pre-pandemic level according to this ONS measure.
There is, however, high variation among different parts of the economy. Output in the consumer-facing services sector, some of the worst hit during the lockdowns, are still 5.5% below their pre-pandemic level. This includes retail, hospitality, entertainment, transport and travel.
There are a variety of factors that could hold back growth. This includes continuing supply shortages, as well as the possibility of pandemic-related restrictions being re-introduced.
High inflation, the reduction in Universal Credit benefit and upcoming tax increases scheduled for April will likely squeeze household budgets. In turn, this may lead to slower consumer spending growth, the key driver of overall economic growth.
There are, however, some indications of resiliency in economy activity heading into the festive period.
Retail sales increased more than expected in October (possibly due to early Christmas shopping), consumer confidence rose in November, and a prominent survey of business activity showed strong growth in November despite firms facing high costs.
About the author: Daniel Harari is a researcher at the House of Commons Library, specialising in UK and international economies.
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