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COVID-19: London macroeconomic scenarios (February 2022 update)

GLA Economics published its latest macroeconomic scenarios-based forecast for London at the end of February. These scenarios have formed part of wider work on the impact of the COVID-19 pandemic on London’s economy, and they have been informed by expert consultation and existing literature on pandemics and macroeconomic scenarios[1]. The two main outcome variables are real Gross Value Added (GVA) – a measure of London’s output – and workforce jobs (WFJ) – a measure of employment. We project both variables over the medium term (to the end of 2024) and we also project GVA over the longer term (to 2031).

In this context, we have developed three main macroeconomic scenarios for London founded on three sets of plausible narratives for the economy.

  1. Fast economic recovery (an optimistic but plausible scenario)
  2. Gradual return to economic growth (the GLA Economics baseline reference scenario)
  3. Slow economic recovery (a plausible pessimistic case)

These scenarios are not definite predictions about the only possible paths for the economy, nor do they represent optimal policy responses. Instead, they rely on judgements around several key assumptions, including the effectiveness of the public health response to the pandemic, and the impact of economic support measures[2]. The scenarios also do not capture the full range of uncertainty about the future, which is likely to be much wider.

Within this framework, we can set out the narrative and key results of the main scenarios. Scenario 2 is our baseline, involving a gradual return to economic growth. While this scenario incorporates the pace of last year’s rapid recovery following positive economic data, it is much less optimistic about the progress of the recovery from this year onwards.  This is due to higher than expected inflation squeezing real household incomes, creating a drag on consumer demand.  The negative effects of higher inflation, which is likely to rise further as a result of the war in Ukraine, more than outweigh the positive news of a more modest than expected impact from ‘Plan B’ restrictions to contain the Omicron variant.

These scenarios were published in the week following Russia’s invasion of Ukraine. There is significant uncertainty around the impact of the war. Assuming conflict does not escalate beyond Ukraine, the main direct impact on London is likely to be through higher energy prices due to concerns over Russian oil and gas supply. However, uncertainty around the scale of this effect and other potential impacts from sanctions sharpen the downside risk to the outlook. We expect rising inflation and tax changes announced last year to hit household incomes, restraining the consumer recovery, and as concerns over Russian energy supplies keep imported costs high, this will contribute to a bumpy path for activity in H1 2022.

Scenario 1, a plausible upside, involves a faster economic recovery. In this scenario, we assume that deaths from COVID-19 rapidly fall to levels similar to endemic diseases like flu as vaccines reduce the pool of individuals susceptible to severe infections and antiviral treatments become increasingly effective. We also assume that strong labour demand means tightening macro policy does not dampen the employment recovery, allowing consumers to release more of their stock of excess savings from the pandemic. The boost to demand raises output and employment, prompting stronger business investment and eliminating the medium-term output scarring in our baseline.

Scenario 3, a plausible downside, assumes that the combination of a new and virulent strain of COVID-19 with higher inflation and tightening macro policy lead the recovery to go briefly into reverse in mid-to-late 2022. Renewed social distancing and squeezed incomes would dent consumer and business sentiment, with increased risk keeping savings elevated, resulting in no release of pent-up demand. A fresh downturn and slow medium-term growth mean there is significant economic scarring, some of which persists in the long term, as firms close and workers lose their jobs (Figures A1 and A2).

Figure A1:

Figure A2:

Overall, while the medium-term paths for output and employment are mostly
higher now than expected at the peak of the crisis, the balance of risks
remains clearly skewed to the downside. The downside potential for London’s
economy is significant, with GVA in the slow recovery scenario ending 2024 over
5% below the baseline, while the upside ends 2023 just over 3% above the
baseline. The breadth of the gap between scenarios also demonstrates that
uncertainty remains very high around economic conditions. As a result, while
our baseline remains reasonably optimistic about the progress of the recovery,
the broader picture of our scenarios for London’s economy is more cautious.

The main results are presented below:

Headline recovery in the medium term (2021 to 2023)

  • Under the gradual return to economic growth scenario, our baseline, London’s real GVA is expected to grow by 4.1% this year. This is a firm pace of growth, but lower than December’s 5% forecast, and sharply down from 2021’s projected growth of 7.8%. The recovery will continue next year, though at a more moderate pace (3.1%), before easing further in 2024 (2.7%) (Figure A3).
  • Real GVA is expected to reach its pre-crisis level in Q4 2021 in the baseline scenario (Figure A1) while WFJs only reach pre-crisis levels in Q4 2022 (Figure A2).
  • Jobs will take longer to feel the impact of the recovery. After ticking up 0.4% last year, employment is set to see moderate growth this year (2.2%) and in 2023 (1.6%) before slowing further in 2024 (1.2%) (Figure A4).
  • Under the fast economic recovery scenario, output growth would stay stronger for longer. In this scenario, output would rise 6.2% this year, before easing closer to long-term averages at 3.5% growth in 2023 and 2.9% in 2024. Employment would also see a much firmer rebound this year, with growth of 3%, followed by a convergence to baseline growth rates from next year.
  • Meanwhile in the slow economic recovery scenario, the output recovery largely ends this year. GVA would grow just 1.4% in 2022 and 2023, before converging towards long-term levels at 1.8% in 2024. Jobs growth also slows to its medium-term pace almost immediately, with growth of 1.1% in 2022, 1.0% in 2023 and 1.2% in 2024. These profiles do not return to pre-pandemic trends over the forecast horizon.

Figure A3:

Figure A4:

  • GLA Economics projections have tended to become more optimistic for output and jobs over successive iterations of our forecasts/scenarios. But the improvements are becoming smaller, especially in the later years of the forecast.

Sectoral output recoveries in the medium term (2021 to 2023)

  • London’s economic recovery is set to vary widely across industries (Table A1).
  • While we expect firm output growth in 2022 and 2023 in much of the economy, the sectors most affected by the pandemic will see output remain below 2019 levels.
  • Examples include Arts and entertainment, where output in 2022 will still be nearly 15% below 2019 levels, despitegrowing a total 28% over two years. Transportation and storage and Accommodation and food services will also lag 2019 output in 2022 despite solid growth, while Construction also faces an incomplete recovery.
  • Other sectors are seeing firm growth despite reaching pre-pandemic output levels last year. This includes sectors that may have adapted faster to home working, such as Information and communication, Financial services or Professional services. It also includes sectors that gain from the shift of consumer demand from services to goods during the pandemic, such as Manufacturing.
  • While Wholesale and retail trade will see output remain well above pre-pandemic levels, high inflation will prompt a contraction in the sector this year.

Table A1: London’s real GVA by industry in 2022 and 2023

Source: GLA Economics. Note: colour coding shows the most negative results in red, the most positive results in green, and results in the middle in white.

Sectoral employment recoveries in the medium term (2021 to 2023)

  • Workforce job projections show that London’s labour market recovery is likely to vary even more widely, with only some of the capital’s core specialist service sectors and the public sector seeing a recovery across this year(Table A2).
  • Sectors hit hard by the pandemic are likely to take the longest to recover. This includes customer-facing service sectors like Accommodation and food services and Arts and entertainment, which now face headwinds from squeezed real incomes.
  • Wholesale and retail trade jobs are set to fall this year amid rising inflation.
  • We expect to see employment in London’s core specialist service sectors push above 2019 levels by next year, even if job growth is set to vary widely. Information and communication and Real estate are set for firm job growth over the two years, while Financial services and Professional services see employment fall in 2022 before staging a recovery next year.
  • Areas of the economy dominated by public sector jobs are projected to generally remain above 2019 levels of employment as departmental spending is set to grow in real terms across the rest of this parliament (up to 2024).

Table A2: London’s workforce jobs by industry in 2022 and 2023

Source: GLA Economics. Note: colour coding shows the most negative results in red, the most positive results in green, and results in the middle in white.

Long-term projections (2024 to 2031)

  • Looking at the longer term, GLA Economics projects that real GVA levels will largely return to pre-crisis trends (the counterfactual) across the next six years,meaning output scarring is confined to the medium term in our baseline (Figure A5).
  • In our fast economic recovery scenario, output pushes above this pre-crisis trend as soon as this year, helping push London’s growth back towards long-term averages.
  • The slow recovery scenario sees London’s output well below the counterfactual in the long term. Heavy scarring in the medium term raises structural unemployment, cuts investment and hits agglomeration benefits, lowering long-term output growth.
  • As discussed above, these scenarios do not reflect the full range of uncertainty and there could be more downside risk in the long term associated with the city’s ability to remain as attractive and competitive as in the two decades prior to COVID-19.

Figure A5:

The scenario results presented in this supplement come within a context of continuing unprecedented uncertainty. Overall, GLA Economics judges that risks are tilted to the downside, especially with the war in Ukraine potentially raising global commodity prices even as consumer incomes already faced a squeeze from higher-than-expected inflation. Other headwinds also skew risks to the downside, including the possible emergence of new COVID-19 variants, global supply chain challenges and the risk of skill and geographic labour mismatches due to remote working. Therefore, GLA Economics will continue to track the economic data in order to review these scenario outcomes in the future. Updates will be released on the London Datastore.

[1] See the list of GLA summaries on external research on COVID-19, which have frequently included summaries of macroeconomic scenarios and forecasts publications.

[2] For more detail on these assumptions see slides 8 to 11.