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London’s Economy Today – May 2022 editorial

Rising prices and higher taxes are squeezing household budgets

Evidence is becoming firmer of the impact of the cost-of-living crisis both on what is happening now, the differential impacts across households, and the possible impacts over the course of the year.

There has been a 57% jump in the proportion of UK households cutting back on food or missing meals over a three-month period according to the Food Foundation. In April, 7.3 million adults said that they had gone without food or could not physically get it in the past month; these households include 2.6 million children. This compares with 4.7 million adults in January.

London appears to have been faring only slightly better than the UK overall with 11.1% of households suffering from food insecurity over the last month compared with 13.8% nationally. That said, the effects may not be felt evenly across the population. Ethnic minorities (which constitute 40% of London’s population) are at higher risk of food insecurity – 22.9% of black households nationally, 23.9% of Asian households, 23.3% of mixed heritage households, 34.5% of other households, and that is compared with 15.7% of white households. Perhaps unsurprisingly Universal Credit recipients (who are disproportionately likely to be in London, and where this year’s uprating will not keep up with actual inflation) are more likely to have experienced food insecurity over the last six months – 47.7% compared with 13.3% of the wider population.

The situation changed in April when the Government brought in National Insurance increases, and did not uprate Universal Credit with the actual rate of inflation. Consequently, 1.5 million households (5.1%) across the UK may face food and energy bills greater than their disposable income in 2022-23, says the National Institute for Economic and Social Research (NIESR). The highest incidence is in London with 6.5% of households, that is 236,000, expected to be affected. This situation will worsen for as long as inflation continues to rise and remains above wage growth and the adjustment of benefits.

The Bank of England (BoE) in its latest Monetary Policy Report projects that total real household income will fall by 1¾% in 2022 despite the support from fiscal measures in the Spring Statement. This is further to negative annual growth in real household disposable income from the second half of 2021. Apart from in 2011, the contraction in 2022 would be the largest since records began in 1964. Although this forecast was produced before the extra measures announced by the Chancellor on 26 May to help households with their energy bills. Households, where they are able, are assumed to respond, in part, by spending more and saving less – richer households might spend some of the savings built up over the pandemic. The household saving rate is forecast to decline from 6½% in 2021 Q4 to 3½% in 2022 Q4, which would be the lowest level since 1999.

Curiously, consumer confidence in London, while extremely weak, is faring better than the UK (the LET indicators in the next section provide more detail). The UK measure is at -40 in April, the lowest level since records began in 1974. The London measure is at -20, which while low by historic standards is still for the moment better than during the financial crisis and the pandemic.

The Bank of England increases interest rates as inflation continues to rise

The 54% increase in the energy price cap in April has fed directly into an increase in the Consumer Price Index (CPI) which rose by 2 percentage points from 7.0% in March to 9.0% in April according to Office for National Statistics (ONS) data. This is the highest inflation rate for 40 years. There were increases, if more moderate, across most elements of goods and services. Worryingly, the prices of some inputs to consumer goods and services such as inputs to manufacturing, and producer outputs have yet to fall (Figure 1). That is, there remain inflationary pressures from inputs.

Figure 1:

The increase in energy prices has not affected households equally. Until March, UK households across all income groups have faced similar rates of inflation, according to the Institute for Fiscal Studies (IFS). As the poorest households spend more of their total budget on gas and electricity, inflation is now hitting the poorest households harder. In April, the bottom 10% of the population in terms of income faced a rate of inflation of 10.9%, which was 3 percentage points higher than the inflation rate of the richest 10%. Most of the difference is because the poorest households spend 11% of their total household budget on gas and electricity, compared with 4% for the richest households. Despite the measures announced by the Chancellor on 26 May further energy cost rises are expected in October with a further rise in the price cap having been announced by Ofgem.

In response to continuing inflationary pressures, the BoE Monetary Policy Committee voted unanimously to raise interest rates by a quarter-point to 1%, its highest level since February 2009. Indeed, inflationary pressures are such that despite the cost-of-living crisis three out of nine members voted to raise rates by half a point.

The BoE expects that CPI inflation will rise further to a peak of slightly over 10% (after the increase in the energy price cap in October). Global pressures are the primary source of inflation and have intensified sharply following the Russian invasion of Ukraine. This largely reflects the further sharp increases in energy and other commodity prices. It also reflects the impact of continued and more widespread disruption to global supply chains on tradeable goods, including the restrictions in China to contain outbreaks of COVID-19. In addition, the shift in global demand towards durable goods and away from services, particularly in the US, continues to put significant upward pressure on tradeable goods prices.

Domestic price pressures have become more prominent and are expected to rise further. Huw Pill, the BoE Chief Economist has commented, “The UK labour market is tight, wages are growing at stronger rates than would normally be deemed consistent with the inflation target, and business confidence is resilient, in part in anticipation of being able to re-establish profit margins. In short, inflationary momentum in the UK is currently strong.” This has been amplified by Brexit reducing the supply of workers, a retreat of globalisation and the lasting effects of COVID-19, which caused almost 500,000 people to leave the UK labour market. “Avoiding any drift towards the embedding of such ‘inflationary psychology’ into the price setting process is crucial”, Pill said, and so further interest rate rises are likely.

As external and domestic pressures subside, CPI inflation is projected by the BoE to fall back to 2.1% in two years’ time, and 1.3% in three years.

New private rents in London are also increasing rapidly

It is not just home buyers who are facing higher housing costs. With people returning to London since the spring of last year newly taken out private rents have been rising. Prior to the autumn of last year new rents were rising more slowly in London than the UK. By the turn of the year annual increases had stabilised in London, if at a level somewhat higher than for the UK, but for the most recent figures for April there is some evidence that the rate of increase may be picking up again (Figure 2).

Figure 2:

ONS figures for all private rents report the slowest growth across the regions in rents in London, although it is likely that this will pick up over the coming months as existing contracts come to an end and are renewed. At the same time the BoE notes the rental market may soften over the coming year as real incomes and confidence are eroded, and borrowing costs rise.

Higher earners have been faring better through the pandemic

There has been a sharp rise in pay in the Finance sector in recent months, at levels not seen in the last decade reports the Institute for Fiscal Studies (IFS). Between 2014 and 2019 growth in UK mean average monthly pay among Finance employees broadly tracked average pay growth across all sectors. Since October 2021 earnings growth in Finance has dramatically pulled ahead of the rest of the economy. By February 2022 average pay in Finance in real terms was 23% higher than in December 2021, while average pay across all sectors was 7% higher.

The picture for London is that the sectors in which London specialises, and where median pay is highest, namely, Finance, Information and communications, and Professional services are those with the fastest pay growth over the last two years. All other sectors have had below average pay growth, and so earnings inequality in London has widened over this period (Figure 3).

Figure 3: London median pay in 2020 vs median pay growth 2020 – 2022
Bubble size represents size of sector

Source: HMRC Real time information system for employee earnings, February 2020 and April 2022

Risks of further trade disruption from Brexit increase

The UK Government is continuing to express dissatisfaction with the Northern Ireland Protocol and the imposition of border controls on goods trade between Britain and Northern Ireland. This maintains the EU single market, and permits the free movement of goods and services, between the north and south of Ireland. Previously the Government has threatened to use Article 16 of the Protocol. This allows the UK or the EU to take unilateral “safeguard” measures if the party reaches the conclusion that the deal is leading to serious practical problems or causing diversion of trade. This would be likely to lead to an immediate response by the EU.

The Government is planning to issue legislation to overturn parts of the Protocol. This would, amongst other things, remove regulatory barriers to goods made in Britain being sold in Northern Ireland and allow the UK to determine tax and spending. The European Commission vice-president in charge of Brexit, Maroš Šefčovič said, “Should the UK decide to move ahead with a bill disapplying constitutive elements of the protocol …, the EU will need to respond with all measures at its disposal.”

Elsewhere, the UK Government has delayed for a fourth time full post-Brexit border checks on imports from the EU until at least the end of 2023. This reduces costs to business, and in so doing helps reduce costs to consumers.

The UK economy shrinks in March and is facing a possible recession

The UK weathered the effects of the Omicron variant well, but the emerging evidence is that the economy is weakening due to the cost of living crisis and may go into recession later this year. The ONS reports that Gross Domestic Product (GDP) fell by 0.1% in March, after no growth in February, although it is now 1.2% above its pre-pandemic level. Services fell by 0.2%, most prominently in the sale and repair of motor vehicles where it fell by 15.1% – this is the fourth consecutive month of negative growth in this industry. According to the Society of Motor Manufacturers and Traders (SMMT) this is the weakest March for new car registrations since 1998, partly reflecting the supply chain squeeze seen in the automotive industry.

The BoE noted that the UK economy had picked up more rapidly than expected after the sharp fall in output at the beginning of the pandemic. Now, the position has reversed and it is forecasting in May slower growth for 2023 and 2024 than expected in February. GDP growth is expected to be the same for 2022 at 3¾%, but is lower for 2023 at -¼%, compared with 1¼% previously, and also lower for 2024 at ¼%, compared with 1% previously. NIESR is more optimistic in its forecast with growth of 3.5% in 2022, 0.8% in 2023, and 0.9% in 2024. The European Commission (EC) expects UK growth of 3.4% in 2022 and 1.6% in 2023 illustrating the range of uncertainty there is around the future path of the UK economy.

More positively, London’s labour market continues to strengthen. Unemployment in London continues to fall while remaining above the UK rate. In Q1 the ONS estimated the London unemployment rate at 4.7% down 2.2 percentage points from a year earlier, and 0.4 percentage points down on the quarter. The UK unemployment rate was 3.7% in Q1 2022.

Global outlook worsens

Increases in energy prices and supply chain disruption are global phenomena. There have been negative developments over the month in three of the world’s most important economies.

The EU has been the most affected part of the world from the rise in energy prices brought about by the invasion of Ukraine. The EC estimates that EU GDP is projected to remain in positive territory over the forecast horizon, thanks to the combined effect of post-lockdown re-openings and the strong policy action taken to support growth during the pandemic. It has, though, downrated its latest Spring forecast for the EU to 2.7% in 2022 and 2.3% in 2023 from 4.0% and 2.8% respectively in its Winter interim forecast.

China’s economic activity deteriorated in April: annual retail sales fell by 11.1% and industrial production fell by 2.9%. Dozens of cities and hundreds of millions of people across the country have been placed under full or partial lockdowns in the pursuit of a policy of ‘zero Covid’. This is in a country where vaccination rates are low, and the vaccines used are perceived as less effective than western vaccines. For example, Shanghai with its population of 26 million has been under lockdown since 1 April. As a consequence port volumes from the city shrank by almost 20% in April with adverse implications for the operation of global supply chains. There are also logistic problems in inland China. Factories have shut, and the country’s patchwork system of regulations governing movement between towns and cities is severely hampering the collection and delivery of cargo.

US annual GDP fell by 1.4% in Q1 2022. The spread of the Omicron variant, and the tapering off and withdrawal of federal funding programmes both contributed to the decline in activity. Additionally, there was a record US trade deficit in goods in March, due to the impacts of the shutdowns in China, and the war in Ukraine. More positively, as a one-off, American firms did not need to re-stock in January as companies had built up inventories to avoid supply chain disruptions over the Xmas period. Further, jobs continue to be created, and business and consumer spending remains robust suggesting GDP may recover over the coming months.

There are thus reasonable fears of recession around the world, and stock markets have been falling as a result.

Business numbers are falling if more slowly in London

Business dynamism may be on the wane as the numbers of businesses in London and the UK is in decline according to figures from the ONS. This trend started around the beginning of 2019 and has continued through the pandemic if more markedly for the UK. It reached the point last year when business closures exceeded births and the total number of businesses in the UK started falling. For London this point has now also been reached, although the picture for the capital is mixed. Business numbers in outer London started falling late last year, while for the moment business numbers are still rising in inner London (Figure 4).

Figure 4:

These trends have been driven by an increase in business closures for both London and the UK. Annual figures for business births have remained broadly flat, as has London’s share of UK births and closures which has remained at around 20% for both activities.

GLA Economics will continue to monitor these challenges and opportunities over the coming months in our analysis and publications, which can be found on our publications page and on the London Datastore.