There’s no doubt the war in Ukraine has clouded the economic outlook. Commodity prices have soared following Russia’s invasion putting more pressure on households’ real disposable income, and dampening growth prospects. But there’s real momentum behind the UK recovery going into this more challenging period, as underlined by last week’s estimate-beating GDP data for January.
The Russian invasion injects further uncertainty raising questions about the availability and price of energy, food and other critical raw materials. Oil is the latest market to show this stress, with prices hitting $140 per barrel, close to all-time highs and a record high when priced in sterling (£99pb). In the meantime, the prospect of an acute real income squeeze will provide a significant headwind to spending. All this suggest that inflation will stay higher for longer. Central bankers have a difficult task ahead in balancing growth during a lingering pandemic and rising prices.
Inflation continued to tick up in January and reached its highest level in 30 years. Last month’s increase is consistent with the Bank of England view that inflation will surpass 7% this spring, which would drive a deep squeeze on living standards. Despite labour shortages, wage growth can’t keep pace with price increases. But soaring inflation and the potential for it to push wages higher will bolster the case for further rate hikes.
The UK economy grew by 7.5% last year – the fastest annual growth since the WWII – despite falling slightly back in December as the Omicron variant dented consumer spending. A much smaller than expected Omicron hit to output was coupled with weak export performance, which continues to lag behind many of our main competitors. In the US meanwhile, inflation keeps rising, putting extra pressure on Fed to speed up its monetary policy tightening.
The Bank of England served a back-to-back rate rise and projected inflation to reach 7.25% in April. The UK is facing the worst squeeze in real disposable income in 30 years. And that’s why Ofgem’s announcement of the new price cap rise was accompanied by a giveaway from the Chancellor to help reduce the cost-of-living crisis.
Persistent inflation will be at the forefront of this Thursday’s Monetary Policy Committee meeting. A rate rise is expected, which would make it the first back-to-back hikes since 2004. And things are getting more challenging elsewhere. The International Monetary Fund warned of “multiple challenges” to the recovery in 2022, downgrading its global growth forecast by half a percentage point to 4.4%. While the US is set to start hiking rates very soon.
Annual inflation recorded its highest level for 30-years in December and is expected to rise further by the Spring, fuelling a cost-of-living crisis. This reading was the last before the next Monetary Policy Committee Meeting in February, suggesting that BoE will look to squeeze demand instead of supporting the economy through its temporary Omicron weakness. Yet the labour market remains healthy, despite Omicron and the end of furlough.
The UK economy turned in a solid performance on the eve of Omicron, with GDP surpassing its pre-pandemic level by 0.7% in November. Meanwhile the Omicron wave is receding, with signs that infections and hospital admissions have peaked. But challenges await. Inflation in the US is at its highest in four decades, with our own multi-decade high soon to come if forecasts are to be believed. A 6% rate would be the highest since the early 1990s.
Omicron knocked back recovery hopes in December. But business adaptation and the fast roll-out of boosters means the setback might well be short-lived and a modest one. Meanwhile, outlasting Omicron and set to be among the big trends of 2022 is the shortage of workers, inflationary pressures and the climate transition. One-in-four cars sold last year were plug-ins of some variety. A reminder that things can change for the better, and fast.
Concerns over the spread of the new Omicron variant prompted the UK to reintroduce restrictions on travel and mask-wearing this week. Difficult decisions lie ahead for the Bank of England, which must balance a potential knock to the economic recovery with evidence of increasingly widespread cost pressures and tight labour market conditions. The odds of a rate hike at next month’s Monetary Policy Committee meeting may be receding but the jury is still out.
