London’s economy recovers strongly although weaknesses remain

This month the Office for National Statistics (ONS) released its first estimate of London GDP growth for Q4 2020 and GLA Economics published its latest scenarios for the London economy. The ONS data show that the drop in London’s economic output in 2020 was less deep than for the UK. Specifically, London’s output fell by 7.1% in 2020, (Figure 1), which is broadly comparable with a fall of 9.8% for the UK economy in 2020 (although this comes from another ONS publication and uses different data sources and methodology.) In the central GLA Economics scenario, the capital is now expected to recover pre-pandemic levels of output by the end of this year, and the level of output it would have had if the pandemic had not happened by 2025. The prediction is for 6.5% growth this year, 6.0% growth in 2022, before slowing to growth of 2.9% in 2023. Two other scenarios accompany the main estimates providing a sense of the range of uncertainty around these estimates (although there remains an element of downside epidemiological risk).

Figure 1:

The Bank of England (BoE) also published its latest forecast for the UK economy in August, in which it expects a recovery to pre-pandemic levels of output by the end of this year. The BoE forecasts UK growth of 7¼% this year, and 6% next year. Also, this month, the International Monetary Fund (IMF) released its latest forecast for the world economy. It continues to expect that there will be global growth of 6.0% this year, and 4.9% next year, but that developed economies would do better than previously expected, and less developed economies worse. The growth forecast for the UK is one that has improved, and is 7.0% for 2021, and 4.8% for 2022.

Furlough numbers are diminishing and business distress indicators are improving

As the economy picks up, and the number of jobs expands, it is becoming less dependent on government support. The Coronavirus Job Retention Scheme (CJRS), or furlough scheme, has been of critical importance in helping employees to maintain contact with their employers. It is due to end in September. The numbers on furlough in London have declined from 883,000 in August last year to 357,000 in June of this year according to HM Revenue and Customs (HMRC) data. Despite this fall London continues to have the highest furlough rate of any country or region of the UK. The city accounts for 12 out of the 15 local authorities with the highest furlough rates across the UK. More positively, recent evidence from the ONS Business Insights and Conditions Survey (BICS) on UK furlough rates indicates that numbers have continued to fall, and 3.7% of the workforce of the UK were on furlough in late July.

Last year the ratio of non-furloughed to furloughed payrolled employees was below one indicating that more people were losing their jobs than moving off furlough to their old roles. Since March the ratio has been above one as employee growth has exceeded the decline in numbers on furlough. This has been the case for both London and the UK (Figure 2).

Figure 2:

UK labour market prospects remain positive as 69% of employers plan to recruit in the three months to September 2021, according to the Chartered Institute of Personnel and Development (CIPD). Redundancies have remained low, with just 13% of employers expecting to make job cuts. If this comes to pass the end of the furlough scheme might be a relatively smooth transition.

However, as reported in July’s LET the picture is not uniform across sectors, and there is a skills mismatch for some sectors. This is notable for hospitality and the arts where the use of the furlough scheme remains common, and there are large numbers of vacancies.

The risk of business failure is also continuing to diminish, according to the London School of Economics (LSE). The percentage of UK businesses at risk of closing over the next three months has been steadily declining from around 15% in January, after the announcement of an unexpected lockdown, to a little more than 6% in July (Figure 3). This is equivalent to around 165,000 UK enterprises, and 35,000 London enterprises, based on ONS figures for 2019. The drop was primarily due to improvements in the outlook of smaller enterprises (those with fewer than 50 employees). The improvement is a cause for cautious optimism, although businesses may remain susceptible to possible disruptions due to new variants or snap-policy changes.

Figure 3: Percentage of UK businesses at
risk of closing over next three months, October 2020 to July 2021

Source: ONS Business Insight and Conditions Survey, and LSE calculations

The stronger than expected recovery from the pandemic has helped companies to regain financial independence. So far, between 5% and 10% of small and medium-sized businesses (SMEs) have missed repayments for the Coronavirus “bounce-back” loan scheme. Preliminary estimates from the government last summer were that between 35% and 60% of businesses might default on loans. Given this the cost of the 100% government guarantees is more likely to be closer to £5bn than the original estimate of £19bn by the Office for Budget Responsibility (OBR).

That said, there are some signs that business confidence in London has been easing in July from the high levels up to June, (see the LET economic indicators section below). Inevitably, the pace of economic recovery will ease off. The Federation of Small Businesses reports declining business confidence amongst London small businesses about prospects for the third quarter compared with the second quarter. Businesses are almost evenly divided about whether prospects for the next quarter are positive or not. Across the UK small businesses are more positive.

Weaknesses remain in the London economy

The latest labour market statistics point to London’s labour market continuing to be disproportionately affected by the pandemic. We have highlighted above how higher furlough take up rates than in the rest of the UK continue to be registered in London even as overall numbers diminish. In addition, London is the only region of the UK which has not yet recovered its pre-pandemic level of payrolled employees. Research by the Resolution Foundation has found that the larger impacts on London’s labour market are only partially explained by the different sectoral composition of London’s economy, as there is also a negative London regional effect (Figure 4).

Figure 4:

A natural explanation for this is a lack of revival of the Central Activities Zone (CAZ). As reported in July’s LET London’s hospitality sector remains disproportionately reliant on the furlough scheme. Partly this is because of fewer people commuting into work, and so fewer people taking advantage of central London’s cafes, restaurants and night-time offer. London is also an important holiday destination for international visitors. It was the third most popular visitor city in the world in 2019 with 19.6m overseas visitors, according to Euromonitor International. International travel restrictions might lead to a £6.6bn spending shortfall in London in 2021, according to the Centre for Economics and Business Research (CEBR). For the whole of England spending this year might be £3.7bn lower than the £14.4bn spent during pre-pandemic times.

Inflationary pressures remain, if weaker for the moment

The rate of increase of Consumer Price Inflation in July was 2.0%, down from 2.5% in June. Much of the difference can be attributed to one-off base effects. Prices for clothing, restaurants, hotels, and furniture were higher than normal as re-opening after the first COVID-19 lockdown led to price rises. Global supply chain weaknesses again helped to push up inflation. With a global semi-conductor shortage affecting the production of new cars, the annual price increase of second-hand cars rose by 14%. Producer prices rose by 9.9% as a sign of future pressure on consumer prices. Other upside risks include an increase in the energy price cap, and the end of the VAT cut for hospitality and tourism, both of which are expected from October. The BoE in its latest Monetary Policy Report expects inflation to reach 4% by the end of the year before easing next year.

As reported in July’s LET there is a debate about whether price pressures will be transitory or become more permanent. While the withdrawal of government fiscal support will ease concerns, the BoE reports a tightening of capacity in the labour market. It observes that the allocation of demand across firms has changed substantially during the pandemic, but jobs have not been re-allocated to the same extent. A large share of that re-allocation of demand appears to have happened within sectors rather than between sectors, for example, if customers buy similar products but from different sources.

A spiral of wage and price inflation might lead to more permanent inflation. But, CIPD research has found that fewer than a quarter of UK companies with hard-to-fill vacancies plan to increase the wages they offer to lure new recruits. Some 44% said they would develop the skills of existing staff, 26% intended to hire more apprentices, 14% said they would do nothing, and 9% would introduce or increase automation (some companies following more than one strategy). The survey indicated that employers’ pay intentions were no higher than pre-pandemic levels. The median employer’s expectation of basic pay settlements has held at the 2% level reached last quarter, after four consecutive quarters at 1%. The BoE has also concluded that wage growth has returned to its pre-pandemic rate, although it is expecting modest increases in wage inflation over the rest of the year.

Office demand is improving in London

In tandem with London’s recovery there have been signs of rising demand for office space despite the move to hybrid working. Knight Frank reports the third successive quarter of rising take-up for leasing transactions in Q2 2021, although CBRE estimates that office vacancy rates increased from 8% to 9.3% in the first half of this year. Derwent London and IWG are also seeing a rebound in office demand with companies favouring newer buildings and shorter leases.

We will continue to review how London’s economy develops, and examine impacts and recovery from the COVID-19 crisis in our research, which can be found on our publications page and on the London Datastore.