London macroeconomic scenarios (August 2022 update)
GLA Economics published its latest macroeconomic scenarios-based forecast for London on 25 August. 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 2032).
In this context, we have developed three main macroeconomic scenarios for London founded on three sets of plausible narratives for the economy.
- Fast economic recovery (an optimistic but plausible scenario)
- Gradual return to economic growth (the GLA Economics baseline reference scenario)
- Slow economic recovery (a plausible pessimistic case)
These scenarios are not definite predictions about the only possible paths for the economy, nor do they necessarily incorporate optimal policy responses. Instead, they use judgements around several key assumptions. The key dimensions of variation focus on resilience to shocks and policy support, especially around the impact of rising inflation. COVID-19 outcomes form part of the background assumptions. The scenarios 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. Following last year’s rapid recovery, this scenario anticipates flatlining growth from the second half of this year and into 2023. Inflation at a 40-year high is squeezing real household incomes and consumer demand is likely to slow. Rising costs and a slowing demand outlook will also drag on businesses’ investment and hiring plans. As a result, we see activity contracting at some point in winter 2022-23, before growth picks up again in late 2023 and into 2024. Meanwhile jobs stagnate around the levels of early 2022 and even fall back modestly in early 2023. Employment then resumes a more normal pace of growth and pushes back above pre-pandemic levels in mid-2023.
London’s lowest-income households are likely to be particularly vulnerable to the cost-of-living crisis. However, for a macroeconomic assessment, it remains important that London has higher average incomes than the rest of the UK. London’s businesses and consumers are also less pessimistic than the UK average in confidence surveys, as reported in the LET indicators. As a result, we do not project a recession for London in our baseline. This contrasts with the downgrade for the UK economy in the Bank of England’s August Monetary Policy Report, which explicitly projects a UK-wide recession in late 2022. At the same time not all of London’s economy is likely to escape recession. Customer-facing sectors are set for a stark challenge, while rising interest rates and slowing demand are also likely to drag on the housing market. Our forecast now sees it taking ten years for London’s output to return to levels consistent with pre-pandemic projections.
Scenario 1, a plausible upside, involves a faster economic recovery. In this scenario, we assume London’s stronger aggregate incomes compared to the rest of the UK offer a partial buffer against inflation as richer households spend more of their pandemic savings. As fiscal support offsets part of the shock to real incomes from the cost of living, most consumers stay afloat with savings or manageable credit. We also assume that still-positive business sentiment sees firms absorb higher costs and flagging demand by moderating hiring and investment, rather than making cuts. A mild winter and stabilising commodity prices allow inflation to peak in late 2022. Output and jobs growth both decelerate in late 2022 and early 2023, but do not contract, maintaining a modest pace of recovery. As demand picks up again in the medium term, this prompts stronger business investment, which helps to eliminate long-term output scarring.
Scenario 3, a plausible downside, assumes that London slips into recession later this year. The drag on real incomes hits the lowest-income households the hardest, and lower-income households tend to spend more of their income. As a result, overall consumer demand suffers heavily, dragging the economy into recession. Global energy and food prices continue rising well into 2023 and a harsh winter combined with cuts in Russian gas supplies sharpen the cost of living crisis. As a result, despite weakening growth, the Bank of England is forced to take an aggressive approach to monetary policy, tightening to prevent rising global prices translating into much higher inflation expectations. Amid slowing demand, higher borrowing costs and rising input prices, businesses cut investment and hiring plans sharply. London’s output dips back below pre-pandemic levels and takes until late 2024 to recover. Jobs similarly fall back, contracting for several quarters until picking up from a trough in early 2023, but only reaching pre-pandemic levels in late 2024. A fresh downturn and slow medium-term growth mean there is serious economic scarring, persisting into the long term, as firms close and workers lose their jobs.
Figures A1 and A2 show the estimated recovery path of London’s output and jobs across the three scenarios described above.
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 risk is clearly skewed to the downside. The downside potential for London’s economy is significant, with GVA in the slow recovery scenario ending 2024 nearly 4% below the baseline, while the upside ends 2023 just under 2% above baseline. The wide gap between scenarios also demonstrates the high uncertainty around economic conditions.
The main results are presented below:
Headline recovery in the medium term (2022 to 2023)
- Under the gradual return to economic growth scenario, our baseline, London’s real GVA is expected to grow by 3.9% this year. This is a firm pace of growth, but mostly driven by momentum in late 2021. This pace is lower than June’s 4.5% forecast, and sharply down from 2021’s estimated growth of 8.5%. Weak demand in the second half of 2022 and early 2023 means growth will slow to a crawl in 2023 (0.5%), before recovering a little in 2024 (1.9%) (Figure A3).
- Real GVA has likely already reached its pre-crisis level in Q4 2021 (Figure A1), and a strong Q1 2022 saw workforce jobs reach pre-crisis levels early this year (Figure A2).
- The jobs recovery makes less progress than output in our baseline. After ticking up 0.3% last year, employment is set to see decent growth this year (2.8%), before slowing in 2023 (0.3%) and reaching a modest pace in 2024 (1.0%) (Figure A4).
- Under the fast economic recovery scenario, demand is resilient for longer, though momentum is still weaker in late 2022 and early 2023. In this scenario, output rises 4.6% this year, before easing to 1.3% growth in 2023 and picking up to 2.3% in 2024. Employment would also see a firmer rebound this year, with growth of 3.1%, followed by a convergence to medium-term growth of 1% from next year.
- In the slow economic recovery scenario, output faces another recession. GVA is up 2.5% in 2022, before a recession this winter sees output average a sharp 1.4% drop across 2023. Output growth then picks up, but to a moderate pace of 1.5% in 2024. Jobs follow a similar pattern, with growth of 2.3% in 2022, a 0.5% contraction in 2023 and 1% growth in 2024. These profiles do not return to pre-pandemic trends over the forecast horizon.
- GLA Economics projections had previously tended to become more optimistic for output and jobs over successive iterations of our forecasts/scenarios. But the latest iterations are seeing this trend reverse, especially in the later years of the forecast.
Sectoral output recoveries in the medium term (2022 to 2023)
- London’s economic recovery is set to vary widely across industries (Table A1).
- The sectors most affected by the pandemic will see output remain below 2019 levels. Examples include Accommodation and food services, where output in 2022 will still be nearly 28% below 2019 levels, despitegrowing 21.8%. Transportation and storage and Arts, entertainment and recreation also lag 2019 output in 2022 despite very strong growth, while Construction also faces an incomplete recovery.
- Apart from Transportation, all these sectors all face a contraction next year as the rising cost of living and high interest rates drag on consumer and housing demand.
- London’s key knowledge-sector export industries are set for resilient growth, such as Information and communication, Financial services and Professional services.
- While Manufacturing has done well out of a shift of consumer demand to goods from services during the pandemic, it faces a contraction next year as demand falls.
- Wholesale and retail trade will see output remain well above pre-pandemic levels, but high inflation prompts a sharp contraction in late 2022 and into 2023.
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. Primary industries are shaded in grey.
Sectoral employment recoveries in the medium term (2022 to 2023)
- Workforce job projections show that for a lot of sectors, London’s labour market recovery will still be incomplete by the end of 2023 (Table A2).
- Sectors hit hard by the pandemic are likely to take the longest to recover. This includes consumer-facing sectors like Accommodation and food services and Arts and entertainment, which are set to fall even further below pre-pandemic job levels.
- Wholesale and retail trade jobs are also set to fall next year amid rising inflation.
- London’s core specialist service sectors face a very mixed outlook for 2022 and 2023. Information and communication is set for resilient job growth over the two years, while Financial services sees weak falling employment in 2022 before picking up next year. Professional services and Real estate follow the opposite pattern.
- Areas of the economy dominated by public sector jobs are projected to generally remain above 2019 levels of employment, though growth is variable as spending plans become more contained in real terms due to higher inflation.
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. Primary industries are shaded grey to avoid them having an outsize influence on shading for the rest of the table.
Long-term projections (2024 to 2031)
- Looking at the longer term, GLA Economics projects that real GVA levels will return to pre-crisis trends (the post-Brexit counterfactual) but that it may take a decade. This does still mean there is no long-term scarring in our baseline (Figure A5).
- In our fast economic recovery scenario, output pushes above this pre-crisis trend in the next five years, 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.
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 further, seeing consumer incomes face an increasingly sharp squeeze from rapid inflation. Other headwinds also skew risks to the downside, including heightened geopolitical tensions, the possible emergence of new COVID-19 variants, ongoing 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 to review these scenario outcomes in the future. Successive updates will be released on the London Datastore.
 These scenarios were developed as 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. See the list of GLA summaries on external research on COVID-19, which have frequently included summaries of macroeconomic scenarios and forecasts publications.
 For more detail on these assumptions see slides 8 to 11.