It forecasts that the UK economy will bounce back strongly from the deep recession of 2020, when the economy contracted by 9.8 per cent. This contraction was deeper than in most countries, with the USA contracting by 3.5 per cent, Germany by 5.1 per cent, France by 8.2 per cent, Japan by 4.7 per cent and the OECD as a whole by 4.8 per cent. But, with the success of the vaccine roll-out, UK growth in 2021 is forecast by the OECD to be 7.2 per cent, which is higher than in most other countries. The USA is forecast to grow by 6.8 per cent, Germany by 3.3 per cent, France by 5.8 per cent, Japan by 2.6 per cent and the OECD as a whole by 5.3 per cent. Table 1 in the Statistical Annex gives the figures.
This good news for the UK, however, is tempered by some worrying features.
The OECD forecasts that potential economic growth will be negative in 2021, with capacity declining by 0.4 per cent. Only two other OECD countries, Italy and Greece, are forecast to have negative potential economic growth (see Table 24 in the Statistical Annex). A rapid increase in aggregate demand, accompanied by a decline in aggregate supply, could result in inflationary pressures, even if initially there is considerable slack in some parts of the economy.
Part of the reason for the supply constraints are the additional barriers to trade with the EU resulting from Brexit. The extra paperwork for exporters has added to export costs, and rules-of-origin regulations add tariffs to many exports to the EU (see the blog A free-trade deal? Not really). Another supply constraint linked to Brexit is the shortage of labour in certain sectors, such as hospitality, construction and transport. With many EU citizens having left the UK and not being replaced by equivalent numbers of new immigrants, the problem is likely to persist.
The scarring effects of the pandemic present another problem. There has been a decline in investment. Even if this is only temporary, it will have a long-term impact on capacity, unless there is a compensating rise in investment in the future. Many businesses have closed and will not re-open, including many High Street stores. Moves to working from home, even if partially reversed as the economy unlocks, will have effects on the public transport industry. Also, people may have found new patterns of consumption, such as making more things for themselves rather than buying them, which could affect many industries. It is too early to predict the extent of these scarring effects and how permanent they will be, but they could have a dampening effect on certain sectors.
So will inflation take off, or will it remain subdued? At first sight it would seem that inflation is set to rise significantly. Annual CPI inflation rose from 0.7 per cent in March 2021 to 1.5 per cent in April, with the CPI rising by 0.6 per cent in April alone. What is more, the housing market has seen a large rise in demand, with annual house price inflation reaching 10.2 per cent in March.
But these rises have been driven by some one-off events. As the economy began unlocking, so spending rose dramatically. While this may continue for a few months, it may not persist, as an initial rise in household spending may reflect pent-up demand and as the furlough scheme comes to an end in September.
As far as as the housing market is concerned, the rise in demand has been fuelled by the stamp duty ‘holiday’ which exempts residential property purchase from Stamp Duty Land Tax for properties under £500 000 in England and Northern Ireland and £250 000 in Scotland and Wales (rather than the original £125 000 in England and Northern Ireland, £145 000 in Scotland and £180 000 in Wales). In England and Northern Ireland, this limit is due to reduce to £250 000 on 30 June and back to £125 000 on 30 September. In Scotland the holiday ended on 31 March and in Wales is due to end on 30 June. As these deadlines are passed, this should see a significant cooling of demand.
Finally, although the gap between potential and actual output is narrowing, there is still a gap. According to the OECD (Table 12) the output gap in 2021 is forecast to be −4.6 per cent. Although it was −11.4 per cent in 2020, a gap of −4.6 per cent still represents a significant degree of slack in the economy.
At the current point in time, therefore, the Bank of England does not expect to have to raise interest rates in the immediate future. But it stands ready to do so if inflation does show signs of taking off.
- United Kingdom Economic Snapshot
- UK growth forecast upgraded but pandemic economic ‘scar’ will be worst of all G7 nations, says OECD
- OECD Predicts UK Economic Growth Amid Vaccine Success And Lockdown Easing
- UK growth upgraded, but OECD warns of deepest economic scar in G7
- UK set for stronger post-Covid recovery, says OECD
- British exports worth billions have faced EU tariffs since Brexit
- Post-Brexit: Businesses hit by labour shortages call for Brexit rules to be relaxed
- Bank of England monitors UK housing boom as it weighs inflation risk
- House prices jump 10.9% as ‘race for space’ intensifies
- Global food prices post biggest jump in decade
- Why house prices are rising so fast in a pandemic
- Inflation: why it could surge after the pandemic
- Inflation might well keep rising in 2021 – but what happens after that?
- Slack in the Economy, Not Inflation, Should Be Bigger Worry
OECD Economic Outlook (May 2021)
Sky News, Ed Conway (31/5/21)
Minutehack Emma Bowden (1/6/21)
The Guardian, Graeme Wearden (31/5/21)
BBC News (31/5/21)
BBC News, Faisal Islam (28/5/21)
Channel 4 News, Paul McNamara (2/6/21)
The Guardian, Larry Elliott (1/6/21)
BBC News (1/6/21)
Financial Times, Emiko Terazono and Judith Evans (3/6/21)
BBC News, Kevin Peachey and Daniele Palumbo (2/6/21)
The Conversation, Ian Crowther (23/4/21)
The Conversation, Brigitte Granville (31/5/21)
Institute for New Economic Thinking, Claudia Fontanari, Antonella Palumbo, and Chiara Salvatori (19/5/21)
Data, Forecasts and Analysis
- OECD Economic Outlook: Statistical Annex
- Forecasts for the UK economy
- Monetary Policy Report
HM Treasury (May 2021)
Bank of England (May 2021)
- What determines the rate of (a) actual economic growth; (b) potential economic growth?
- What is meant by an output gap? What would be the implications of a positive output gap?
- Why are scarring effects of the pandemic likely to be greater in the UK than in most other countries?
- If people believed that inflation was likely to continue rising, how would this affect their behaviour and how would it affect the economy?
- What are the arguments for and against having a stamp duty holiday when the economy is in recession?