UK economy recovering faster than expected, but much slower growth could be ahead, reveals latest EY ITEM Club forecast

‣       EY ITEM Club forecasts UK GDP contraction of 10.1% in 2020, an improvement on the 11.5% fall expected in July’s Summer Forecast.

‣       GDP likely grew around 16-17% q/q in Q3 2020 – four to five-percentage points faster than had been expected.

‣       However, the EY ITEM Club expects Q4 growth will be 1% or less.

‣       The UK economy is predicted to grow 6.0% in 2021, down from the 6.5% expansion previously anticipated.

‣       EY ITEM Club does not expect UK economy to return to pre-pandemic size until after mid-2023.

NORTH WEST, Monday 12 October 2020 – The UK economy’s initial recovery from recession has been much faster than expected, according to the EY ITEM Club’s Autumn Forecast, but future growth prospects have been downgraded.

In its latest forecast, the EY ITEM Club says GDP likely grew around 16-17% q/q in Q3 – much faster than the 12% growth predicted in July’s Summer Forecast – but growth of 1% or less is expected in Q4, while the growth forecast for 2021 has been lowered from 6.5% to 6.0%.

After Q3’s boost, the EY ITEM Club now expects the economy to contract 10.1% in 2020, an improvement from the 11.5% contraction forecast in the Summer.

The strong Q3 performance was driven by consumer spending and the release of pent-up demand as COVID-19 restrictions were relaxed. However, these effects will wane heading into Q4, while the economy will also face the end of the furlough scheme and likely higher unemployment, tighter COVID-19 restrictions and uncertainties around the future of the UK-EU trading relationship. Conversely, the latter issue may provide some lift to Q4 growth if uncertainties over a deal result in stockbuilding ahead of the 31 December deadline.

The UK economy is now predicted to regain its pre-pandemic size in the second half of 2023, compared to Spring’s forecast of Q1 2023 and Summer’s late-2024 forecast.

Howard Archer, Chief Economic Advisor to the EY ITEM Club, comments: “The UK economy has done well to recover faster than expected so far. Consumer spending has bounced back strongly while housing sector activity has also seen a pick-up, in part thanks to the Stamp Duty holiday. Government intervention continues to provide much-needed support but, even with this boost, many of the factors that supported the pick-up in growth in Q3 are now beginning to fade, notably the release of pent up demand and relaxation of lockdown restrictions.”

Government spending and investment are forecast to contribute significantly to growth in 2021, with Government investment up 10.7% following a 10.5% increase in 2020.

Unemployment outlook weighs on consumer spending

Consumer spending was a key factor in the economy’s Q3 performance and was supported by unemployment levels remaining relatively low, Government schemes like ‘Eat Out to Help Out’ and sector-specific cuts to VAT.

However, with the furlough scheme ending in October, unemployment is forecast to reach 7% by the end of the year before peaking at 7.7% in mid-2021.

The Government’s new Job Support Scheme (JSS) is expected to have some limiting effect on unemployment. The forecast rise in unemployment to 7% by the end of 2020 is an improvement on the 9% expected in the Summer Forecast, which was published before the JSS was announced. The reduced unemployment forecast for end-2020 also reflects the economy’s stronger-than-expected recovery in Q3.

Consumer spending is forecast to fall 12.8% in 2020 – as a result of a record 23.6% q/q contraction in Q2 and rising unemployment later in the year – before increasing 7.6% in 2021 (up from the 6.6% forecast in July). Next year’s improvement will be helped by low inflation and an improving labour market as the year progresses, although the EY ITEM Club report warns that not all jobs lost in 2020 will be recovered quickly.

Average earnings are expected to grow by 2.4% in 2021 after falling 0.3% in 2020.

Stephen Church, Office Managing Partner for EY in Manchester comments: “With the labour market key to the region’s economic recovery, an important task for businesses will be managing their talent. Many business leaders across the North West will be thinking carefully about how they can best support their people, while balancing the changing demands on their business.

“It’s positive that the Government has sought to replace the furlough scheme which has undoubtedly helped many of the region’s companies to retain staff. While unemployment across the North West is still likely to rise once the furlough scheme ends, lower than expected unemployment levels should help support regional and national economic growth later on.

“The new Job Support Scheme (JSS), which comes into effect in November, requires employers to contribute more to employee pay than the furlough scheme and may be more likely to appeal to businesses that want to retain skilled employees, such as those in manufacturing or high value-added services, which are key to the North West. However, in the region’s hospitality and retail sectors, where output is more directly linked to hours worked, the JSS may have less of an impact.”

Business investment outlook

Business investment has been constrained throughout 2020, a pattern which is forecast to continue into 2021. A 21.9% contraction in investment is expected this year, followed by a 3.5% contraction in 2021 – although the latter figure masks quarter-on-quarter growth through the year. An increase of 11.1% is expected in 2022.

Net trade is expected to make a two-percentage point contribution to GDP growth in 2020, as a result of imports (down 18.1%) falling faster than exports (down 11.5%). This situation will reverse in 2021 with imports (up 16.3%) outpacing exports (up 10.6%).

Stephen Church continued: “The economy looks set to start 2021 with less momentum than previously hoped for and the next few quarters will be a test for many. The North West business community has some obvious challenges to deal with in the short-term and investment may not be on the agenda at the moment for some. This is a difficult time to be making decisions, especially those with longer horizons such as capital investment, but greater certainty towards the end of next year should provide the region’s businesses with the confidence they need to execute their plans.

“Companies will need to think carefully about how they navigate the impact of COVID-19 on their customers, teams and supply chains, while at the same time ensuring they have taken the necessary steps to be ready for the end of the Brexit transition period at the end of the year. Further out, companies will need to start preparing for when the economy starts to show signs of sustainable growth.”

Further stimulus prospects

Given the increased risks facing the economy, the EY ITEM Club suspects the Bank of England will announce further asset purchases at the November or December Monetary Policy Committee (MPC) meetings, most likely around £100bn, which would take the total value of purchases up to £845bn.

Howard Archer adds: “It looks unlikely that the Bank of England will cut interest rates below 0.10%. While the Bank continues to review the case for negative interest rates, we suspect the MPC will maintain the view that such a move is not in the best interests of the UK economy.”

Downside risks to the forecast

While a vaccine could provide a positive boost to growth forecasts, the EY ITEM Club warns that risks are weighted to the downside of its latest economic forecast. Key risks include pent-up demand waning, increased restrictions on activity due to rising COVID-19 cases, uncertainty around the future UK-EU relationship and a significant rise in unemployment as the furlough scheme draws to a close in October.

The latest forecast also notes that, even if further virus outbreaks are contained and major restrictions on economic activity are avoided, consumers and businesses could remain cautious in their behaviour for an extended period.

The outcome of EU-UK trade negotiations will have a significant impact on the forecast, which assumes a “bare bones” Free Trade Agreement will be agreed by 31 December. Without an agreement, growth of 4.8% is forecast in 2021 (down from 6.0%) and 2.6% in 2022 (down from 2.9%).