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London’s Economy Today – December 2021 editorial

Omicron variant leads to the introduction of targeted measures

In the run up to the Christmas holidays the new Omicron variant of COVID-19 was discovered in Southern Africa. Cases have quickly been reported in Europe, including the UK, and around the world, with examples of community transmission being reported. At the time of writing preliminary data on the variant indicates that it spreads more rapidly than the Delta variant and may be the dominant variant in the capital.

In response to Omicron, the vaccine booster programme was rolled out to all adults in England. Meanwhile, following the discovery of the Omicron variant some restrictions were reintroduced such as the travel red list, which was initially reapplied to travellers from some Southern African countries. This list was gradually expanded before being removed with the evidence of widespread transmission of the variant in the UK. Mandatory mask wearing in shops and public transport was also reintroduced in England. This was then extended on 8 December to most public enclosed spaces like theatres and shops (but not to pubs and restaurants), while workers were advised to work from home from 13 December if possible. And nightclubs, indoor unseated venues of more than 500 people, outdoor unseated venues of more than 4,000 people, and any venue with more than 10,000 people are required from 15 December to have people show their vaccination status or negative test result on the NHS Covid Pass.

In response to these measures representatives for sectors that have already been heavily hit by the pandemic said that these measures would hurt them further. For example, Craig Beaumont, chief of external affairs at the Federation of Small Businesses, said “It’s a double whammy. Christmas parties are already being cancelled, but this could turn the lights out for many struggling hospitality businesses”. These measures come at an awkward time for the hospitality industry with the period before Christmas being the time bars and restaurants make most of their profits. Even before the announcement on 8 December footfall in London’s hospitality sector had not yet returned to pre-pandemic levels (Figure 1).

Figure 1: Individual personal activities in London, March 2020 – December 2021, relative to pre-COVID-19 baseline

Individual personal activities in London, March 2020 – December 2021, relative to pre-COVID-19 baseline

Source: Grocery and retail metrics from Google Mobility, social venues (bars, event spaces etc) from Purple public Wifi and restaurant bookings from OpenTable

It is difficult to predict how the emerging news on the Omicron variant will playout in the coming weeks. Still, if no new lockdown is imposed London’s economy should see continued growth, although at a slower rate than initially expected. However, a large peak in infections leading to a larger number of workers self-isolating could have temporary disruptive impacts. Further, as noted, although the aggregate prospects for the economy remain generally positive this does not apply to all sectors of the economy, with Arts and entertainment, Accommodation and food services, and Transportation and storage likely to face renewed challenges.

London’s Labour market shows continued recovery

Before the news about Omicron, ONS data on London’s labour market remained positive showing a continued improvement in employment in the three months to October. The employment rate was estimated to stand at 75.4% between August and October 2021, up 0.5 percentage points (pp) on the previous quarter and up 0.6pp from a year earlier. This rate was marginally below the 75.5% seen for the UK as a whole. London’s unemployment rate was estimated at 5.4% in the three months to October, a decrease of 0.6pp on the previous quarter and of 1.2pp from a year earlier. However, the capital’s unemployment rate was still significantly higher than the 4.2% seen for the UK as a whole. More timely data from the count of payrolled employees from HMRC’s Pay As You Earn dataset shows that there were around 4.2 million payrolled employees living in London in November 2021, an increase of around 55,400 or 1.4% on the previous month. This was also an increase of 241,000 or 6.2% on the previous year and compares to a UK average increase of 4.8%. Relative to pre-pandemic levels (February 2020), the number of payrolled employees in London is up by 2,390 or 0.1%. This compares to an increase of 1.5% across the UK on average. However, the number of payrolled employees is still below pre-pandemic levels in 16 out of 33 of London’s local authorities.

Uncertainty is high for the global economy

The Organisation for Economic Cooperation and Development (OECD) has warned that the Omicron variant adds to high global economic uncertainty. Thus, when their latest Economic Outlook forecast was published their chief economist, Laurence Boone, said that the variant was “adding to the already high level of uncertainty and that could be a threat to the recovery, delaying a return to normality or something even worse”. In terms of the UK the OECD expected strong growth of 6.9% in 2021, slowing to 4.7% in 2022 and 2.1% in 2023, although this forecast was produced before the discovery of the Omicron variant. Inflation was expected in the forecast to peak at 4.9% in the first half of 2022.

The UK is not expected to return to pre-pandemic levels of output until the beginning of 2022, while output in most OECD countries is now close to or above pre-pandemic levels according to the OECD. That said global GDP in mid-2021 was still 3½% lower than projected before the pandemic. This forgone growth has not been distributed equally. The loss has been proportionately greater for middle-income emerging-market economies as a group, and greatest for low-income developing countries. Growth within countries has also been uneven. Contact-intensive sectors and lower-income households have been particularly hard hit, as has been the case in London, contributing to the incomplete recovery in labour markets. The OECD is expecting world growth in 2021, 2022 and 2023 of 5.6%, 4.5% and 3.2% respectively.

Elsewhere, concerns about the heavily indebted Chinese property developer Evergrande continue to mount with the credit ratings agency Fitch downgrading its debt to being in “restricted default”. With these worries affecting other firms in China’s real estate sector there are growing concerns about the impact this may have on China’s economy.

Inflation continues to increase and the Bank of England raises interest rates to address this

Inflationary pressures remain strong in the UK economy as consumer prices, and manufacturing input and producer output price inflation continue to rise (Figure 2). Consumer price inflation rose to 5.1% in November up from 4.2% in October, and 3.1% in September – with the increase being broadly based across goods and services, and reflecting underlying drivers such as supply chain shortages and rising energy prices.  In a tightening labour market, there is also some evidence that wage inflation is extending beyond occupations and sectors where there were specific shortages, such as truck drivers. The inflation rate by all three measures is higher than the rates reached due to the sterling exchange rate depreciation after the EU Referendum. Then the Bank of England (BoE) considered that increase to be a one-off which would pass through the statistics after some time, and so did not increase interest rates. It is increasingly clear that this approach will not work during the current crisis, despite many of the pressures being transitory, and the markets expected an interest rate increase in November which did not happen. The International Monetary Fund (IMF) has argued for an immediate increase in interest rates as it felt that the risks of undermining confidence were offset by the benefits from restraining demand and allowing inflation to become even more persistent – it estimates that inflation will rise to 5.5% in the Spring of 2022, and will only return to the BoE 2% target by early 2024. Taking account of rising inflation the BoE voted to raise interest rates by 0.15pp to 0.25% on 16 December, reversing the second cut in interest rates that occurred in March 2020 in response to the pandemic. This rise was the first increase in rates since August 2018.

Figure 2:

Customs controls for imports from Europe due to come into effect

Outside of the continuing fallout from the pandemic, changes to the UK trading relationship with Europe due to Brexit continue to pose a further, ongoing challenge to the UK economy. These are set to accelerate in 2022 with the imposition of full customs controls on imports from the EU on 1 January 2022, although some controls, such as certificates and physical checks on agri-foods and plant imports, are postponed until 1 July. These controls where initially due to come into effect on 1 October 2021 but were delayed in part due to the pandemic. The Federation of Small Businesses has warned that a survey they conducted found that only one in four small importing firms were ready for these changes, with a third of surveyed firms being unaware of them until surveyed. The OECD has noted that “increased border costs following the exit from the EU Single Market are weighing on imports and exports”, even before these changes had taken effect.

Zoomshock – the estimated shift to the suburbs of London’s economic activity

Previous LET editorials have reported on the shift in demand for retail and hospitality services from central London to outer areas and outside London with remote working during the pandemic. A University of Sheffield economic research series paper estimates that the fraction of work done from home in England and Wales will increase by 20 percentage points post-pandemic (in 2022) over its pre-pandemic level, rising to nearer 30 percentage points for workers in London. The increase is highest for western areas of the city along the river (Map 1). This reflects that the re-location will be greater for better paid professional occupations, which will skew spending toward the most socio-economically affluent geographic areas. Around £3.0 billion in annual national retail and hospitality spending (1.5% of total spending), or around 77,000 jobs, may re-locate away from urban centres to more widely dispersed residential areas, or be lost. For London, the re-location or loss of spending may be by £1.5 billion, and 38% or £0.56 billion of this total might leave the city. Spending may fall by as much as 34.7% at Canary Wharf, and 31.6% in the City of London. It may go up by over 50% in three areas of London, South Hampstead (68.1%), Tooting Bec Common (57.8%), and Millwall South (57%). This analysis, though, does not take account of the impacts on office space, nor the loss of tourism on central London’s retail and hospitality sector, which potentially might be far larger than that from less commuting.

Map 1: Estimated percentage point change in remote working 2022 over 2019, London, Middle Super Output Areas (MSOAs)

Estimated percentage point change in remote working 2022 over 2019, London, Middle Super Output Areas (MSOAs)

Source: De Fraja G et al (2021). ‘Covid reallocation of spending: the effect of remote working on the retail and hospitality sector’, Sheffield Economic Research Paper Series 2021006

Note: figures estimated as a percentage of neighbourhood workforce

London’s share of public expenditure increases during the pandemic

Looking at the history of the pandemic HM Treasury has published analysis of regional public expenditure for 2020/21. UK expenditure rose by 29% from £797bn to £1,026bn (in cash terms). Expenditure in London rose by 43% from £98bn to £139bn. Nationally health expenditure increased by 24%, while in London it rose by 19%. Expenditure on economic affairs more than doubled in both London and the UK, reflecting the introduction of the furlough scheme, expenditure on Universal Credit, the Eat Out to Help Out scheme and revenue support for transport operators in the absence of fare revenue from commuters. The London estimates also reflect the labour market challenges the capital has faced, the fact that it has made a disproportionately large use of the furlough scheme and its comparatively greater rise in the claimant count. Prior to 2020/21, London was making a much greater contribution to the Exchequer in taxes than it was receiving in expenditure.

Growth in output continues and is currently expected to do so into the new year

The ONS has published its first estimate for London’s GDP growth in Q1 2021, the time of the last lockdown. Quarter-on-quarter London’s GDP fell by 0.1% in this quarter, which demonstrates that the capital’s economic activity has become more resilient through periods of restrictions on movement.

More surprisingly, London’s productivity (output per hour) rose by 3.4% between Q1 2020 and Q1 2021. While output fell by 3.4% over this time, hours worked fell by more at 6.5%.  Curiously, while increasing hours and jobs will increase output, it may weaken productivity growth if it is in lower productivity sectors such as hospitality. Productivity dynamics may be complicated over the coming months and years. The effects of Brexit are likely to be a drag, as might the recovery of the tourism sector, but the greater use of digital technologies may be a boon, as it has been in the shift to online retail.

The latest ONS UK monthly GDP estimates make plain the imbalances in the national economy as it recovers. UK service sector activity has now returned to its pre-pandemic level (by this way of measuring GDP) and grew by 0.4% in October – the service sector accounts for 80% of UK economic activity, and 90% of London activity. This however hides differences in the service sector as consumer-facing services are 5.2% below their pre-pandemic levels, while all other services are 1.4% above. In total, however, UK GDP as a whole only grew by 0.1% in October indicating the issues faced by the economy even before the Omicron variant.

The GLA Economics outlook for London is provided in our latest macroeconomic scenarios, which are also the subject of this month’s supplement. It confirmed that economic growth has been healthy this year, and that output is likely to recover to pre-pandemic levels by Q1 2022. The jobs recovery will be slower, reflecting the decline in arts and hospitality in central London from fewer commuters and tourists, and is not expected to recover to pre-pandemic levels until Q1 2023.