Economic outlook: Autumn 2021

Regardless of where one stands vis-a-vis the great issue of Brexit, both sides acknowledged that a modicum of pain would be involved with the process. Those against feared that the pain would be insurmountable and that despite its obvious shortcomings, the EU wasn’t worth leaving. Those for believed that short and even medium-term pain was a worthy price to pay for an envisioned ‘new Britain’. What neither side could have ever predicted 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 economic arrhythmia

Global supply chain arrythmia after a protracted pandemic is a key feature shaping the global economy today. As western consumers went into lockdowns 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, significantly pushing up transportation costs. According to Clarksons, a UK-based shipping broker, costs to transfer goods from China to the US have risen by 350% and to Northern Europe by a whopping 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 disruptions persist, keeping many parents away from employment or forced to work from home.  

The state of the British economy

The challenges for British people are exacerbated due to Brexit complications. Waiting times in ports are increasing further due to increased paperwork. Imports through the Irish sea are becoming contentious. Where 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, put further angst on 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 abating. 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 (PMI), 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 slowly coming back to life, with 60% of Britons now saying that they are returning to some sort of regular commute. 

UK economic outlook

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 world’s 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.

Policymakers in Downing Street are also considering changes in the economic mix and fiscal stimulus especially following the end of furloughs. However, they are probably holding out for the US government decision 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.

Inflation 1.0 and inflation 2.0

We left the thorny 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 policymakers 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, we would not only see a significant rise in disposable income, but also interest rates, to keep the economy from over-heating.

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. 

What does it all mean for business?

Business sentiment should fall slightly in the coming months, as consumption reverts to trend.

Consumers will probably become a little more apprehensive as savings run out. Meanwhile, with furlough concluded and more workers becoming available again, wage pressures and competition for talent should abate and skill availability should increase.

Businesses should not expect supply chain pressures to abate any time soon, however. In addition to these, Brexit-related issues could persist for some time, especially as tensions between the continent and the UK rise. Empty shelves and reduced availability (and thus demand) for goods should be a feature for this winter. This would put pressure on the Chancellor to maintain enough fiscal stimulus, even if it means more debt, raising taxes or a combination of both.