Interactive Investor

UK economy: forecast up for this year, but 2022 downgraded

The UK economy has staged a rapid recovery but supply constrains mean inflation forecasted to go higher.

27th October 2021 14:21

Tom Bailey from interactive investor

The UK economy has staged a rapid recovery, but supply constrains mean inflation is forecast to be way above target. 

The UK economy is expected to recover to its pre-Covid 19 levels of outputs faster than expected, according to the latest forecasts from the Office of Budget Responsibility (OBR).

Announced in the Autumn Budget by chancellor Rishi Sunak, the latest figures show the size of the UK economy is expected to return to its pre-pandemic levels around the turn of the year. Notably, that’s faster than the forecast from the OBR during the March Budget, when it said it expected the UK economy to return to size in the third quarter of 2022.

This pick-up in growth has largely been the result of the successful vaccine roll-out and opening up of the economy. However, this surge in demand has not been without its downsides. Supply has struggled to meet the robust rebound in demand, in the form of workers, energy and bottlenecks in global supply chains. As a result, inflation is expected to peak at 4.4% next year.

The inflation forecast is higher than previous estimates. In March, the OBR forecast that inflation in 2022 would mostly fall short of 2%, the Bank of England’s target rate. Now, inflation expectations next year exceed the Bank’s target, raising the prospect of interest rate rises to attempt to keep a lid on the cost of living.  

Over the past few weeks, there’s been plenty of speculation that the Bank of England would raise interest rates before the end of the year, much earlier than had previously been expected, sending bond prices down and yields up. The risk, however, is that the Bank raising rates would be the equivalent of stamping on the breaks of the UK economy just as it is starting to accelerate.

For now, however, growth expectations are strong. The OBR expects the UK’s GDP to grow by 6.5% this year, up from the 4% it previously estimated. This would make the UK economy one of the fastest-growing advanced economies in the world.

However, the UK also saw a sharper drop-off in economic growth during the pandemic than most advanced economies.

Yet this forecast is more conservative than those from many other organisations. Earlier this month, the International Monetary Fund (IMF) forecast growth of 6.8%. The Bank of England has predicted growth of 7.3%.

However, it should be noted that the 2022 forecast for UK economic growth has been downgraded. In the March Budget, the OBR said it expected growth in 2022 to be 7.3%. In the latest Budget, those expectations fell to 6%.

The 2023 and 2024 growth forecasts are 2.1% and 1.3%. The respective forecasts in March were 1.7% and 1.6%.

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