Mass vaccinations have stimulated a revitalization of the domestic U.K. economy in recent months, which is resulting in a rapid normalization of consumer behavior.
We see the U.K. economy growing at a greater than 7% rate this year.
The manufacturing sector had already begun recouping losses during the pandemic, and the increased consumer spending will aid in sustaining a recovery. This underscores our expectation that the U.K. economy will grow at more than 7% this year as the recovery turns into an expansion.
According to the Office for National Statistics’ monthly gross domestic product index, the U.K. production sector grew by 3.6% in March (compared to March 2020), and the services sector grew by 0.7%. That makes March the first month since before the pandemic that both sectors grew.
It’s too soon to declare victory, however. The seven-day moving average of newly reported COVID-19 cases has doubled in recent weeks, and there is the threat of the spread of variants. This increase, along with price volatility as demand outpaces supply, are the major risks to the outlook.
Even if the vaccination program proves to be successful, the damage to the economy during the pandemic will be heaped onto longstanding issues that have yet to be resolved.
For instance, real capital investment has yet to recoup the losses from the pandemic, adding to the decline that was in place since 2015. Without adequate investment, the U.K. is likely to lose competitive advantages in the new global economy.
Still, we expect a resurgence in fixed business investment, along with household consumption, to be the major drivers of the recovery.
Finally, there are base-year effects created by comparisons to last year’s low levels that will overstate the health of the economy. For those reasons, and even though we expect exceptional growth in the coming months, we expect the monetary and fiscal authorities to continue their accommodative policies well into next year.
Manufacturing and industrial production
Industrial production increased by 3.6% in March compared to the pandemic-deficient March 2020. Manufacturing production increased by 4.8%, and sentiment among U.K. manufacturers remains elevated.
The importance of the manufacturing sector to the health of the overall economy can be seen in the first figure below, with manufacturing retaining an outsized role in creating employment and income in downstream service-sector enterprises. The second figure below shows the interconnectedness between the U.K. and German productive sectors, and for that matter, between the U.K. and the world.
Consumer confidence and spending
After increasing by nearly 8% in March compared to March 2020, retail sales in April increased by an incredible 37.7%. Much of that increase could be written off by base-year effects because sales dropped off the map during April 2020.
But even compared to the retail sales index of the month before the pandemic, retail sales still managed to grow by 13%. So the retail sales gap has been closed in a hurry by consumers relieved to be spending again.
The increase in retail activity mirrors the improvement in consumer confidence, which has returned to March 2020 levels, but is still far from where it should be.
Consumer confidence has been in general decline since 2015, with that peak coinciding with the national election and the onset of an era of austerity. This suggests that despite the gains in the consumer sector, this is not the time for the monetary and fiscal authorities to take their feet off the pedal. The sharp increase in retail sales is more likely because of pent-up demand than runaway spending.
Labor market
The labor market is tightening, but that does not mean it is tight. Instead, the economy is reopening after a horrific shock, and the normalization of employment and wage trends are to be applauded as signs of a recovery.
After peaking in December, the unemployment rates for men and women have been declining. Men are unemployed at the rate of 5% and women at 4.5% as of March. And for the first time in 12 months, the number of employed increased in March.
Wages are also showing signs of readjusting after being skewed by pandemic furloughing. Nevertheless, we can say that manufacturing wages that are growing by less than 2% per year in inflation-adjusted terms are far from a threat to price stability. Rather, we might prefer the higher growth of wages that was signaling higher rates of economic growth.
External sector
U.K. exports as a share of total exports to the European Union dropped in the runup to Brexit, and they have continued to fall during the first three months of the year. As of March, U.K. products constituted 8% of the European Union’s total imports, down from 10% at the end of 2019.
In a similar pattern, U.K. imports of European Union products constituted 11% of the EU’s total exports, down from roughly 14% at the end of 2019.
Given the time still needed for the U.K.’s trading partners to recover from the pandemic, we might anticipate a recovery in trade in the months ahead. But given the normal amount of time to negotiate trade agreements—and the deceleration and decline in U.K trade already in place before the pandemic—the lack of exports will likely be a drag on GDP growth for years to come.
Inflation
With prices increasing after a year of decline, there is talk that the monetary authorities should take away the punch bowl, clamping down on the chance of runaway inflation.
Retail price inflation jumped from a 0.5% yearly rate in August 2020 during the pandemic to 1.5% in March and then to 2.9% in April. But that coincides with transitory shortages of products and increases in energy costs as demand picked up again and as OPEC cut back on production.
The Bank of England looks at the consumer price index, which moved higher from last year’s 0.3% to 1.5% in April. That’s hardly something to get worried about, particularly since 10-year interest rates dropped below 1% in May 2019 and have remained there.
For more information on how the coronavirus pandemic is affecting midsize businesses, please visit the RSM Coronavirus Resource Center.
