There were two early Christmas surprises in this month’s economic news, as the Bank of England raised interest rates after a surprisingly fast rise in inflation. While this isn’t necessarily good news, there is also reason to think that things might not be too gloomy.

This Insight looks at economic data released this month, and what it might mean for the months ahead.

Prices are rising faster than expected

Inflation figures published this month show that prices are rising fast. November’s figure of 5.1% was the highest in a decade and driven by almost all sectors of the economy (although transport, and particularly fuel prices, was the biggest contributor).

Inflation was widely expected to increase as the global economy began to recover from the pandemic, with the Office for Budget Responsibility (OBR) forecasting in October that it would peak at around 4.4% in the middle of next year. Most independent forecasters surveyed by the Treasury in December expected inflation to be around 4% by the end of this year, but as the chart below shows, the actual figure of 5.1% in November is higher than almost all of them predicted.

Chart showing inflation in November is higher than previous forecasts.
ONS, time series D7G7; OBR, Economic and fiscal outlook – October 2021; HM Treasury, Forecasts for the UK economy: December 2021

Because of this increase, along with other economic data, the Bank of England’s Monetary Policy Committee (MPC) voted in December to raise the Bank’s interest rate from 0.1% (its lowest ever level) to 0.25%. This was the first rate rise in over three years, and was a surprise to many economists (the MPC had been widely expected to raise rates in November, but then didn’t, and to leave them unchanged in December). The Bank now expects inflation to reach a peak of around 6% next April before falling back.

Services slowing as Omicron starts to hit

The Bank of England’s rate rise came in the face of increased uncertainty caused by the new Omicron variant of Covid-19. Although it is too early to tell exactly what effect the new variant will have on the economy, there are signs that some sectors are starting to be hit by it.

As the chart below shows, the Purchasing Managers’ Index (a measure of both current and expected economic performance) indicated that growth in the services sector was slowing in December due to less customer demand. Other indicators of Omicron’s impact include cancelled bookings in the hospitality sector, lower retail footfall, and lower passenger numbers on the London Underground. For more information, see chapter 1 of the Library’s briefing Coronavirus: Economic impact.

Chart showing that growth in the services sector was slowing in December 2021.
Source: IHS Markit, Purchasing Managers’ Index data

However, the most recent employment data from the Office for National Statistics (ONS) shows that the labour markets have held up well following the end of the furlough scheme. The unemployment rate fell to 4.2% in August-October 2021, down from 4.6% in the previous quarter, and is now only just above pre-pandemic levels.

This good news may have been one reason why the Bank of England decided to press ahead with its rate rise, assuming that the economy would not be hit too hard in the coming months.

Economic growth overall remains vulnerable

Following an extremely volatile couple of years, economic growth has been fairly flat in recent months. As the chart below shows, monthly figures show that the economy grew by only about 0.1% in October, much lower than October’s 0.5% and below economists’ expectations.

A chart showing month-on-month growth rates in GDP since the start of 2021. The economy contracted by 2.3% in January, but has grown in almost every month since then. In October growth was almost flat, at 0.1%.
Source: ONS, GDP monthly estimate, UK : October 2021

Some of the slowdown may be due to disruptions in trade due to both Covid-19 and Brexit, with both imports and exports still well below their 2019 levels. Supply chain issues have also had an effect, although comments from PMI surveys suggest these may be starting to ease.

The economy has mostly coped increasingly well with each phase of the pandemic so far. Despite some weaknesses and uncertainty, particularly around the impact of the Omicron variant and possible policy responses to it, it seems likely that we are at least not on course for a repeat of the economic woes of 2020.

About the author: Philip Brien is a researcher at the House of Commons Library, specialising in public spending.

Photo by Philipe Cavalcante on Unsplash

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