Jeremy Peat: Economy is performing strongly, but risks remain

Survey evidence and reports from various respected forecasters are suggesting that the pick-up in the UK and Scottish economies through the remainder of this year could be more pronounced than previously expected.

Of course, like any economist, I must point out that there are risks and uncertainties and – in the dismal scientist’s favourite phrase – these are skewed to the downside.

Let us start with the positive. The International Monetary Fund now expects UK GDP to grow by 7% this year, significantly higher than its previous estimate and above expected growth in Germany, France and Italy. The EY ITEM Club shares this view, forecasting growth of 7.6% in 2021and 6.5% in 2022.This implies that UK GDP will regain its pre-Covid level by the end of this year. Just a few months ago most forecasters were suggesting that this would not be achieved until late 2022 or even 2023. This rapid growth is expected to result from three main factors, a mechanical bounce back from previous GDP decline; continuation of loose monetary and fiscal policy; and a boost to consumption as savings behaviour returns to more like normality, given liquid household wealth for some, based upon enforced savings during lockdowns, and a continuation of low unemployment. (Of course by no means all households have faced positive times.)

The unemployment story merits emphasis. A year back forecasters were suggesting that unemployment could reach 8-10% by the end of 2020. In practice the unemployment rate rose from 4% pre-Covid to a peak of ‘only’ 5.2% in late 2020, and has declined to 4.8% in the latest three months. This is much less of an increase than during recessions in the 1990s and 2000s. Clearly the Government’s furlough scheme has had a major beneficial effect. Relatively low unemployment and low unemployment expectations have helped to stabilise and now galvanise consumption.

Turning to Scotland, GDP increased by 0.9% in May and is now less than 3% below pre-pandemic levels. Further, the Fraser of Allander Institute’s quarterly Business Monitor suggests a reasonably bullish attitude among the 500 companies surveyed. Their results indicate that volume of business, employment and turnover all continued to increase in Q2 2021; and that businesses are confident that these trends will continue into the second half of the year.

Whilst there are inevitably differences between sectors, it is most encouraging that a positive balance of companies in all sectors is reporting increased volumes of business in Q2. But business life is not positive for all. There has been a marked increase in recent months in the number of Scottish companies entering liquidation. Nevertheless, the Business Monitor reports a marked increase in the % of companies confident of continuing to trade over the coming 6 months.

In sum our economy has performed much better than expected over the past 18 months and the central expectation for businesses should be that growth of demand will continue at pace throughout the remainder of 2021 and into 2022. But now it is time to turn to those risks. The pandemic remains one such cause for concern. None of us can know with any degree of certainty that the worst is over and that some renewed constraint on activity will not be needed. Leaving that to be noted but placed on one side, there are economic risks of substance.

As discussed last month one such risk is inflation. The inflation outlook and implications for monetary policy are dividing the Monetary Policy Committee. At their last meeting two members were sufficiently concerned about the latest numbers, and pockets of tight labour market conditions, to point to earlier policy tightening than previously expected. At the same meeting, however, three MPC members veered in the opposite direction, towards a softer stance.

We can expect a further increase in inflation in the months ahead, driven by the recovery in the oil price, a significant increase in input prices for producers and supply-side bottlenecks for re-opening sectors experiencing high demand. Inflation could easily reach 3.5% by year end, as compared to the MPC’s 2% target. In order for the Committee to maintain its ultra-soft monetary stance members will have to be persuaded that this increase is transitory. There are good reasons to believe that this will be the case. Over the past 30 years we have become accustomed to low inflation. Inflation expectations look set to stay low, helping to achieve that end. The oil price has recovered to pre-pandemic levels, and that increase should be working its way out of the data over the months ahead. We must also hope for a steady easing of supply disruptions as the global economy recovers, and an easing of labour supply constraints for most sectors.

In this context the MPC must hold its nerve and maintain that loose monetary stance. Similarly the UK Government must maintain its loose fiscal stance. Just as economic performance has exceeded expectations so Government borrowing, whilst reaching record highs, has fallen far short of the levels anticipated. The deficit in 2020/21 was some £295 billion, as compared to a relatively recent Office for Budget Responsibility forecast of £400 billion. The deficit in 2021/22 should be well below the OBR forecast of £233 billion, and this should allow for greater support for those most adversely affected by the pandemic.

The Scottish Government has created a new Council for Economic Transformation to advise on policies for the next decade. Whilst maintaining a sceptical stance on such bodies, based upon prior experience, let me suggest two key areas for their attention.

The first is the old chestnut of productivity in Scotland. The outlook for investment is not bright, so how can the Scottish Government encourage innovative investment across all sectors and incentivise businesses to make best use of the available labour supply, enhancing labour productivity inter alia by learning from lessons perforce learnt in recent months? Second, the impact of the pandemic has been far from uniform. To generalise, the young and the worst off have suffered much more than the older and wealthier. What policies can now work towards renewed ‘levelling-up’, whilst also aiding and abetting the drive to higher productivity? That should keep the Committee busy and gainfully employed.

The Herald Scotland

The Herald Scotland

The Herald is a Scottish broadsheet newspaper founded in 1783. The Herald is the longest running national newspaper in the world and is the eighth oldest daily paper in the world. The title was simplified from The Glasgow Herald in 1992