Household finance squeeze leads to growth downgrade prediction for 2022

The bounce back in the UK economy was stronger than expected last year, but the EY ITEM Club’s Winter Forecast has nevertheless downgraded its projections for UK GDP growth for 2022. The EY ITEM Club believes that UK GDP grew 7.3% in 2021, up from the 6.8% predicted in its previous forecast. Growth of 4.9% is now expected in 2022, down from 5.6% in November’s Autumn Forecast.

The forecast revisions are prompted by the Omicron variant’s impact on activity at the start of 2022 and the prospect of a significant squeeze on households’ spending power from high inflation.

In the latest forecast, inflation is expected to reach almost 7% this spring – significantly higher than the 5% peak expected in November’s Autumn Forecast. This is expected to prompt the Bank of England to raise Bank Rate to 1% by the end of the year.

However, the EY ITEM Club remains optimistic about the prospects for the economy and believes the UK is likely to benefit from a robust jobs market, a rebound in business investment, and a boost to sentiment as another COVID-19 wave recedes.

The EY ITEM Club forecasts growth to reach 2.7% in 2023, up from 2.3% in the previous forecast, with the economy making up for the Omicron variant’s impact on 2022 growth. GDP growth is then expected to settle at 1.8% in 2024 and 2025.

Hywel Ball, EY’s UK Chair, said “The forecast shows that the economy’s bounce back in 2021 was stronger-than-expected and Omicron’s economic impact is likely to be temporary and limited. While the economy and UK businesses may have a softer launch pad for growth this year, they will still benefit from a number of tailwinds in 2022 and 2023.”

“But blowing in the opposite direction will be a squeeze on household spending power which is expected to be a bigger headwind for the economy than the Omicron variant. Inflation is set to reach its highest level in thirty years by the spring and will be well ahead of pay growth.”

“Although the latest forecast says that the economic scarring from the pandemic is likely to be minimal, policymakers still face the challenge of how they help support households through the forthcoming squeeze on their finances and give companies the confidence needed to unlock business investment. The push towards Net Zero certainly creates an opportunity for investment growth.”

Consumer spending is now on course to grow 5.7% in 2022 and 5.6% in 2023, according to the EY ITEM Club, with the forecast for 2022 downgraded from the 6.8% growth expected in the autumn report.

But while 2022 looks like it may be the year when average worker pay falls in real terms for the first time since 2017, the EY ITEM Club says that a consumer spending recovery will be supported by a natural bounce back from the lifting of restrictions, Omicron hesitancy receding, historically high levels of household savings, and low unemployment.

The EY ITEM Club expects the unemployment rate to remain stable at its end-2021 rate of 4.1% until the middle of 2022. It is then forecast to decline to just under 4% by the end of the year. This would be historically low – only two years since 1971 have seen a jobless rate of 4% or less.

Martin Beck, Chief Economic Advisor to the EY ITEM Club, said “Despite an inflationary squeeze, there is still plenty of support for consumer spending, not least the unwinding of the high levels of savings accumulated by many households over the course of the pandemic.”

“However, not all households will have built up savings in the pandemic and those that haven’t are also more likely to be affected by the impact of the higher energy costs. Households will benefit from targeted government help on energy costs, but the measures announced will not fully offset the squeeze on household incomes. As a result, this year is likely to see an increase in polarisation between the economic experience of high- and low-income households.”

The EY ITEM Club expects inflation to fall back to the Bank of England’s two per cent target in the first half of 2023 as energy prices stabilise and global imbalances between demand and supply ease – although the unprecedented nature of the pandemic means the forecast notes that it is difficult to make this call with any degree of certainty.