Rising commodity and energy costs prompt downgrade to EY ITEM Club UK GDP forecast

• In a special Interim Report, the EY ITEM Club has downgraded its 2022 UK GDP growth forecast to 4.2% from the 4.9% expected in February’s Winter Forecast. GDP growth of 1.9% is forecast for 2023, down from 2.7%.
• Inflation is now expected to peak at 8.5% in April – the highest level since 1982 – rather than the 7.2% forecast in February.
• The EY ITEM Club’s 2022 consumer spending growth forecast is down to 5.1% from 5.6%, and to 1.7% from 2.9% for 2023.

NORTH, MONDAY 28 MARCH 2022 – The EY ITEM Club has downgraded UK GDP growth projections for 2022 and 2023 in a special Interim Forecast published today, with the impact of the war in Ukraine being felt by the UK economy.

UK GDP is now expected to grow 4.2% in 2022, down from the 4.9% forecast in early February’s Winter Forecast. Growth of 1.9% is forecast in 2023, down from 2.7%.

The war in Ukraine has prompted a rise in energy and commodity prices, which have placed a drag on UK economic activity. Rising prices will add to already-significant UK inflation – now expected to peak at a forty-year high of 8.5% in April, up from the 7.2% peak predicted by the Winter Forecast. The EY ITEM Club expects inflation to still be close to 6% by the end of 2022, and to not fall back in line with the Bank of England’s 2% target until late-2023.

The forecast adds that, while high and low-income households have recently experienced similar levels of inflation, the incoming 54% rise in typical home energy bills in April means lower-income households could experience an inflation rate of around 10%. With further energy bill increases expected in October, the EY ITEM Club says lower-income households are likely to experience persistently higher levels inflation, relative to their higher-income counterparts, well into 2023.

Hywel Ball, EY’s UK Chair, says: “The UK economy entered 2022 in good shape, but the weaker outlook now reflects an assumption that energy prices will be higher for longer, adding to the cost of living and inflationary pressures already weighing on businesses and households.

“UK consumers will benefit from some protection from the most recent increases in gas prices, with the energy price cap preventing these from feeding through into bills until October. Businesses don’t have access to the same support though and also face rising capital goods prices, further disruption to their supply chains, and prolonged uncertainty. These factors will inevitably pare back the expected post-pandemic bounce back in business investment.”

The EY ITEM Club says business investment is now forecast to grow 11.3% in 2022, down from the 12.7% forecast in February.

Higher inflation and low wage growth cut into consumer spending forecast

With inflation projected to rise to the highest level since 1982, and with the EY ITEM Club expecting 2022 to see the biggest fall in real wages since at least the global financial crisis, the new Interim Forecast has cut expected consumer spending growth to 5.1% in 2022 (down from the 5.6% predicted in February) and 1.7% in 2023 (from 2.9%).

The EY ITEM Club’s report does note that consumer spending will benefit from some supports. Unemployment is close to a record low and some households can access savings built up in the pandemic. The measures announced by the Chancellor in the Spring Statement will go some way to mitigating cost of living pressures. Moreover, the repayment of household debts during the pandemic has created room for fresh consumer borrowing, while the declining share of households with a mortgage – and the growth of fixed-rate mortgages – will limit the impact of the Bank of England raising interest rates.

However, the EY ITEM Club adds that the coming cost of living squeeze will exacerbate economic inequality which, combined with a shift in consumer spending back to services away from goods, will create challenges for some goods sectors.

The EY ITEM Club’s report estimates that social distancing restrictions and heightened consumer caution meant cumulative spending on consumer services was almost £230bn lower between Q1 2020 and Q3 2021 than it would have been had spending continued its pre-pandemic trend. By contrast, cumulative spending on consumer goods over the same period was up £6.5bn.

Martin Beck, chief economic advisor to the EY ITEM Club, says: “With the worst of the pandemic seemingly behind us – and with restrictions on activity eased – we expect to see consumer spending starting to rotate back towards services rather than goods. This will pose challenges for some goods sectors, particularly those for which low-income household spend is relatively more important, such as household appliances, books and newspapers, and toys, games and hobbies. By contrast, sectors which rely more on high-income household spend – including hotels and accommodation, and vehicles – look better-placed to weather economic pressures.

“Consumer spending is a key part of the UK economy, and the expectation has been that the passing of the worst of the pandemic would spur a corresponding consumer recovery. But the war in Ukraine and rising energy prices mean that the outlook has dimmed. The Spring Statement included some help for households, but a consumer squeeze is on the way in 2022, particularly with significant increases in home energy bills in April and potentially in October.”

The EY ITEM Club says that, after rebates, a typical household energy bill could be just short of £2,500 by October 2022 – almost double the £1,277 typical bill in March 2022.

Meanwhile, the EY ITEM Club forecasts average pre-tax pay to rise by around 4% over 2022, well behind average inflation of 6.5%. Benefits payments are due to rise by only 3.1% in April, which will exacerbate cost of living pressures facing those on low incomes.

Martin Beck adds: “Higher inflation is not automatically a problem for consumer spending if it is accompanied by correspondingly higher wages. After all, the 1970s saw both the highest inflation rate and the strongest household real income growth of any post-war decade. The signs now, however, are that pay will not keep pace with price rises, even before the addition of higher National Insurance Contributions and tax allowance freezes.”