Global and UK economic outlook
Those for believed that short and even medium-term pain was worth the price for an envisioned ‘new Britain’. What neither side could have ever contemplated was that Brexit, really a trade challenge, would be implemented at the height of the greatest trade disruption the modern world has ever known.
Global supply chain arrythmia after a prolonged pandemic is a key feature shaping the global economy today. As western consumers went into lockdown and shops closed, production across the world slowed or halted altogether. Not knowing how the pandemic would play out, producers decided not to over-stock, but wait. After the Covid-19 vaccine was licenced, developed economies quickly came out of their slumber with a lot of pent-up demand. Factories in the east struggled to cope. As a result, huge backlogs were created, pushing up transportation costs exponentially. According to Clarkson’s, a UK-based shipping broker, costs to transfer goods from China to the US have risen by 350% and to Northern Europe by a whooping 890% in the last year. Waiting times in ports have almost tripled since before the pandemic. This sort of disruption means shortages of imported goods and inflation, an economic element most modern consumers haven’t really experienced in over twenty years. Companies like Intel forecast microchip shortages for all of 2022. After the initial rebound, global growth is now slowing again, even as the pandemic continues to grip countries with low vaccination rates, where most supply chains begin. The labour force is also struggling to cope, as school program disruptions persist, keeping many parents away from employment or forced to work from home.
The challenges for British people are exacerbated due to complications surrounding Brexit. Waiting times in ports have increased due to additional paperwork. Imports through the Irish sea are becoming contentious. Whereas in other countries labour participation rates have dropped, in the UK the situation is made worse by the mass exodus of European skilled workers. As a result, and despite adequate inventories, British people are experiencing gasoline shortages due to lack of drivers. Similar pressures can be seen across hospitality, retail and construction, where at least the pool of workers is large enough to keep those industries afloat. Overall, shortages of skilled labour pushes wages higher. Housing prices rising 5% to 15% per annum, adding further concern for consumers. All of these factors are further exacerbating inflation which has reached 3% per annum, a level not seen for nearly a decade and with no signs of slowing down. Meanwhile, economic output (GDP) virtually stalled, up only 0.1% for the three months to July 2021. We are now entering an economic phenomenon called ‘Stagflation’ (Stagnating Growth + Inflation).
Despite those conditions, the Bank of England, whose primary objective is to fight inflation, has adopted a more ‘hawkish tone’ (econo-speak for a more aggressive approach to interest rates).
On the other hand, we have to note that not all news is bad. UK businesses are overall the most optimistic they have been since 2017. Consumers, empowered by higher savings, fiscal stimulus, low unemployment and a shift of bargaining power towards labour, are less worried about higher prices than they would be otherwise. Purchase Manager Indices, popular forward-looking economic indicators, suggest that while economic activity is slowing, overall conditions are still expansive, and the pace of the slowdown is actually lower than what we would have anticipated. Meanwhile, empty city centres are gradually coming back to life, with 60% of Britons now saying that they are returning to their regular routine.
The pandemic is very much still with us, with different variants threatening further economic instability. And while western consumers may be the first to learn to ‘live with Covid’, supply chain disruption may well last into 2023, or at least until the problem has been dealt with on a global scale. The UK, one of the most open economies in the world, is especially sensitive to those disruptions. Having said that, the UK, also one of the worlds seven biggest industrialised economies, still has the resources and a strong enough currency to weather the storm.
The IMF has improved the aggregate growth outlook for 2022 from +3.1% to +4.3%, with some estimates bringing the number up to 5.5%. Macroeconomic volatility will probably persist into the next year as well, but we would expect fewer surprises as vaccination rates increase and the pandemic eventually subsides. We also expect the gradual return of the services and retail sectors to conditions close to pre-2020 after mid-next year.
We believe employment friction will continue well into the next year. The pandemic augmented ‘Brexodus’ and it will take some time before the UK has a big enough supply of skills to smooth economic performance.
Policy makers in Downing Street are also considering changes in the economic mix and fiscal stimulus especially after the end of furloughs. However, they are probably holding out for the US government decisions as to how much the world’s premier consumer economy will fiscally inflate its own output, the consequences of which will reverberate across the world.
We left the difficult issue of inflation for last. Supply deflation was the biggest gift of globalisation. As long as supply chains remain global, supply side inflation is considered by and large transitory. Even if de-globalisation trends pick up, modern logistics chains have ways to efficiently source and produce. Having said that, if Chinese economic and political convulsions persist, we could see the transfer of factories to other countries, an event with at least a two-year impact on inflation and production capacity. This is inflation 1.0, one for which central banks and local policy makers can do very little about.
Then there is inflation 2.0, demand inflation. In the past twenty years, real incomes have stagnated across western economies. Demand has been muted and savings rates have picked up, especially after 2008. The US, the world’s premier economy, is now considering breaking this cycle, with massive fiscal stimulus. If this does happen, other countries would have to follow, for fear that their currencies would rise in value and they would lose competitiveness.
Central banks may well maintain low-interest rates if ‘Inflation 1.0’ remains dominant. But if and when western consumers become more empowered, they we would not only see a significant rise in disposable income but also interest rates, to keep the economy from overheating.
Inflation 1.0 is already happening, and the only relevant question is one of duration. Inflation 2.0 is the possibility of an empowered consumer. How and when this second part will occur, whether it will overlap with the first or leave a gap are still difficult questions with significant policy implications.
If you’d like further information on any subjects discussed in this article, please don’t hesitate to get in touch via the form below.
In our October newsletter, we focus on: our predictions for tax changes in anticipation of the upcoming autumn budget, the changes coming into effect around NIC and dividend tax rates, the importance to SME businesses in evaluating their supply chains, an outlook on the UK and global economies and how family vendor assisted management buyouts work.
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