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London’s Economy Today editorial – August 2022

Inflation rises strongly again

Annual UK Consumer Price Index inflation (CPI) rose to 10.1% in July, up 0.7 percentage points from the June rate of 9.4%, according to the Office for National Statistics (ONS). This is the highest rate of inflation since 1982, according to ONS modelling. Rising food and non-alcoholic drink prices made the largest contribution to the change – there was a 2.3% increase in these prices between June and July. While excluding energy and food prices inflation has levelled off for the moment at around 6%, stabilising or falling food and energy prices may well not be sufficient to address wider inflationary pressures. This is because the increase in inflation is broadly based with rises in both goods and services inflation (Figure 1).

Figure 1:

The price of package holidays also rose much faster this year than in 2021. Increased demand for overseas vacations and the restricted supply of flights have helped to bring this about. Heathrow airport has extended its cap of 100,000 passenger numbers a day to the end of October as staff shortages of ground handling companies remain.

The rise in inflation in the UK has been stronger than in other G7 countries and most European nations. This reflects the UK’s greater use of gas, and domestic energy prices are set to rise significantly again in October and January when Ofgem resets the energy price cap. Strong private sector pay increases, and the ease with which companies are passing on higher costs to customers also contribute. A ray of good news is that the annual growth in input prices to manufacturers eased slightly this month perhaps because of improving supply chain conditions.

Cost of living pressures deepen

Paradoxically despite high nominal (inflation unadjusted) wage growth compared with recent years, UK living standards fell in the second quarter of 2022 according to ONS analysis. Among UK employees, growth in average total pay (including bonuses) was 5.1%, and growth in regular pay (excluding bonuses) was 4.7%. After inflation, growth in total and regular pay fell on the year in April to June 2022 at 2.5% for total pay and 3.0% for regular pay – this was a record fall for pay. In London, nominal employee pay growth stabilised in July, while inflation accelerated which in turn led to further negative real pay growth (Figure 2).

Figure 2:

The labour market remains tight with unemployment rates low and employment rates high for both the London and UK labour markets. The exit of one million people over 50 from the UK labour market, and the bar on low skill workers coming to the UK to work following Brexit have constrained labour supply. This has contributed to UK average total nominal pay growth for the private sector of 5.9% in Q2 2022, and stronger bargaining power for workers. In the public sector inflation-adjusted budgets have become tighter as inflation has been higher than expected, and total pay growth was 1.8% in Q2 2022.

Looking at the strains facing Londoners, the GLA City Intelligence Unit has also published this month its second Cost of Living report. It brings together much of the reporting on this subject in this and other LET editorials over the last few months, as well as other bespoke investigations. New analysis suggests that prices are rising faster in London than the wider UK, and that food is one of the largest pressures pushing the capital’s inflation above the national average. Also of note is the conclusion that in past periods of high inflation a recession has followed.

UK growth falls in the second quarter of 2022

The UK economy contracted in the second quarter of 2022 according to data published by the ONS. The data showed that in the three months to June UK output fell by 0.1% (Figure 3), although GDP remains above its pre-pandemic peak by 0.6%.

Figure 3:

Output in the services sector fell by 0.4% in Q2 2022 with the largest contributor to the fall coming from human health and social work activities as COVID-19 related activities were rolled back. However the ONS noted that “the fall in services output was partially offset by increases in output from accommodation and food services”, with increases also seen in other service activities and arts, entertainment and recreation. Looking at the monthly GDP data June saw a drop in output by 0.6%, following downwardly revised growth of 0.4% in May. The ONS also noted that “real household expenditure fell by 0.2% in Quarter 2 2022, which was driven by falls in net tourism, clothing and footwear, food and non-alcoholic beverages, and restaurants and hotels”.

Bank of England forecasts possible UK recession at the end of the year

The Bank of England (BoE) published a new forecast for the UK economy in August in their Monetary Policy Report. The report showed that the BoE had significantly reduced its baseline forecast for the UK and now expects a recession at the end of this year (Figure 4). The BoE notes that the slowdown “reflects the adverse impact of the very sharp increases in energy, non-energy commodities and tradable goods prices on UK household real incomes and spending”. Beyond this the BoE observed that “these pressures will intensify in October when the very large increases in wholesale energy prices feed through to households following the reset of the Ofgem price cap. As a result, household real incomes are projected to fall further and sharply, and GDP is expected to decline by nearly 1% in 2022 Q4. GDP is forecast to fall further in the subsequent four quarters, as real incomes continue to decline”.

Figure 4:

The BoE also undertook a projection for a situation “in which energy prices follow their downward-sloping futures curves throughout the forecast period”. In this forecast “the UK economy still enters recession, but activity is stronger in the second half of the forecast, as the pressures on real incomes ease to a greater extent”. Looking between these two projections “the peak-to-trough falls in output in the baseline and alternative projections are 2¼% and 1½% respectively”.

Despite the projected slowdown in the economy with inflation continuing to rise the BoE has again increased interest rates. The BoE thus raised rates by 50 basis points to 1.75%. This was the sixth increase in the bank rate since December and the biggest increase in 27 years.

World economies still slowing

Economic data from a number of countries has been published in the past month which showed a general slowdown in their economies. US GDP data for the second quarter of 2022 contracted by an annualised rate of 0.9% compared to the previous quarter. This followed on from a decline of 1.6% in Q1 2022. Inflation in the US moderated a touch in July as petrol prices dropped back, with inflation slowing to 8.5% down from 9.1% in June.

Closer to home the Eurozone saw strong growth in Q2 2022 with its economy growing by 0.6%, stronger than the 0.1% growth expected by commentators. Spain, Italy and France all grew in Q2 (by 1.1%, 1.0% and 0.5% respectively), although Germany’s economy stagnated with growth standing at 0.0%. The European Central Bank (ECB) has also been intervening to protect the more indebted members of the Eurozone by buying up their debt. Thus, between June and July the ECB injected €17bn into Italian, Spanish and Greek markets using its pandemic era bond buying programme according to Financial Times calculations. At the same time its portfolio of German, Dutch and French debt declined by €18bn.

London faces a range of challenges in the post-pandemic period

This month’s supplement reports on the latest iteration of GLA Economics macroeconomic scenarios. As with the BoE forecast for the UK it is more pessimistic than previous forecasts about the future. Unlike the BoE’s forecast of an impending recession for the UK, this forecast is predicting weak growth over the coming year. The indicators section of this LET shows that business confidence is holding up, and consumer confidence, while negative, is higher than for the UK. This reflects that there are relatively more well-off people, who still have the security of savings incurred during the pandemic.

Curiously, despite the weaker prospects for London’s economy the private rental market in the capital continues to heat up. While the ONS Index of Private Housing Rental Prices has London annual rent growth as the lowest in the UK at 1.7% in June the data on new private rents shows a different picture. Trends were similar in London and the rest of the UK prior to the pandemic when rents fell as people left the capital. Rents started to pick up as people returned from the spring of last year. Annual increases reached double digits late last year, and have continued to remain high by historic standards (Figure 5). Zoopla found that rents increased by nearly 20% in inner London in the first quarter of 2022, and by 10% in outer London. As well as increased demand the supply of private rented accommodation has fallen sharply in London to a five-year low after buy-to-let investors reduced their exposure during the pandemic.

Figure 5:

GLA Economics will continue to monitor these and other aspects of London’s economy over the coming months in our analysis and publications, which can be found on our publications page and on the London Datastore.