It may be a little premature to bring out the bunting but, nevertheless, the UK economy is finally bigger than it was before the onset of the Covid crisis. The Office for National Statistics proudly announced on Friday that “gross domestic product… is above its pre-coronavirus pandemic level for the first time, by 0.7 per cent”.
Impressive stuff, particularly when other countries have failed to follow suit. Germany, for example, is still languishing, held back in part by its dependency on a manufacturing sector which has proved particularly vulnerable to the worldwide shortage of semiconductors.
And, just possibly, it might get even better. With Omicron seemingly less threatening than earlier versions of the dreaded virus, we might be close to the point at which we learn to live with, rather than run away from, Covid. Whether that means that “working from home” is about to end is, of course, another matter entirely: many companies — particularly those operating in the pricier parts of London — are doubtless hoping to reduce their office rents on a more permanent basis.
Yet, before we get too excited, we need to recognise that the most recent gains in economic activity partly reflect the huge November increase in booster vaccinations. It’s good news that more of us have higher levels of protection against Covid than we enjoyed before, but it’s pushing it a bit to argue that we’re somehow enriched as a result. In an ideal world, resources devoted to vaccines could have been used for other, more enjoyable, activities.
In any case, there are two important constraints on UK growth in the months ahead.
The first is simply that big chunks of the world are still under threat of being locked down. More than half of UK residents have now received a booster. Yet Germany is at only 45.8 per cent while both China and the US are at 23.6 per cent. Australia’s down at 18.0 per cent and Russia stands at 5.5 per cent. For those nations who, as yet, don’t have adequate levels of protection, and who have adopted a “zero-tolerance” approach to Covid, the risk of further lockdowns remains considerable. That means both disrupted supply chains and a reduction in the mobility of workers across borders. Neither of these is conducive to a rapid economic expansion in the UK alone.
The second, linked, constraint is inflation. With activity only barely above its level almost two years ago, inflation at 5.1 per cent — way above the Bank of England’s 2 per cent target — might seem a bit odd. After all, economists tend to associate inflation with too much demand but, thanks to repeated lockdowns, demand has been mostly missing in action over the last couple of years.
In truth, however, what matters is the level of demand relative to available supply, and supply, unfortunately, has been melting away of late. In the US, more people than usual have opted for early retirement, either because they’re fearful of catching Covid in a work environment or because, thanks to a booming stock market, their pensions are unusually flush. In the UK, there are a record 1.2 million vacancies. Some of this may reflect a lack of worker movement across borders, thanks either to Covid uncertainty or Brexit. Some may reflect a lack of investment, leading to a shortage of capital and, hence, an increased demand for labour.
The US and UK are, however, nothing special. Inflation is rising elsewhere too. A combination of supply shortages alongside “build back better” attempts to boost demand has doubtless contributed to the emergence of global price pressures, most obviously in energy.
That, in turn, raises a tricky issue for the UK. In normal circumstances, a two-year period in which output barely rises would be associated with continued very low interest rates. Yet the inflation costs to the UK economy have gone up. Perhaps the effects will be temporary. Many are warning about a “cost of living crisis” over the coming year, in which demand will eventually fall as prices outpace wages. If, instead, wages rise in response to higher prices, a cost of living crisis will begin to look more like a wage-price spiral. At that point, the Bank of England may have to perform the economic equivalent of a handbrake turn, delivering higher interest rates even if the economy remains subdued. Maybe it’s time we fastened our seat belts.
Stephen King is HSBC’s Senior Economic Adviser and author of Grave New World
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