The Calm Before the Storm: Has the economic bounce-back, fuelled by “staycationing”, masked the real state of the economy?

October 20, 2021

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4 min read

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What's going on here?

During August the UK experienced an economic bounce-back after demand for domestic holidays boomed. However, economists question whether this was simply a glimpse of sunshine through a cloudy economic backdrop as economic growth already appears to be decelerating.

What does this mean?

This summer, unprecedented numbers of British holidaymakers flocked to UK holiday destinations instead of their typical international locations, attempting to make the most of the summer despite stringent (and confusing) restrictions still being in place for foreign travel. Being the first month without any Covid controls, August witnessed increased spending in the hospitality, food and accommodation industries, particularly helpful for small, local business owners in these sectors.

The aforementioned industries have contributed the most to the economy’s August growth, with the ONS saying that GDP rose by 0.4%. However, this figure should not cloud the fact that GDP still stands 0.8% below its pre-pandemic level. Kevin Brown of the investment manager Scottish Friendly points out how people were still enjoying the “fruits of the end of lockdown” in August whereas that expansion is now wavering as cost pressures rise, demand attempts to catch up and both material and labour shortages are becoming more common.

What's the big picture effect?

All things considered, a key current issue for the UK is not necessarily a dire economy but an uncertain one. Uncertainty arises in two regards: firstly, the potential state and direction of the economy and secondly, what actions need to or will be taken to control the economy.

Taking the first point, whilst the holiday and service industries boomed in August, the retail sector was hit hard with a 0.9% fall in sales in the month to August 2021, creating uncertainty about the general direction of the economy. Also, despite job vacancies reaching an all-time high in June-August, the furlough scheme’s recent end conjures uncertainty about how the labour market will recover and what will happen to many workers’ jobs. This is especially so when considering the labour market’s current chronic skills shortage. Paul Craig, a portfolio manager at Quilter Investors, highlighted the continuing pressure on the economy caused by recent supply, labour (especially driver) and skills shortages and how this would “no doubt weaken [economic] growth expectations”.

Delving into the second point, policymakers, faced with an economy experiencing dampened growth prospects and a rapid rise in prices, will face a conundrum over how to support the economy, potentially exploring options such as low interest rates and bond buying. Lower interest rates make it cheaper to borrow money, often reducing consumers’ incentive to save and hence encouraging increased spending. Increased spending (in theory) naturally leads to economic growth. Bond buying is a method used by governments that wish to borrow money, whereby a government sells bonds to investors to raise money. Hence, funds raised from bond buying can be pumped into various sectors of the economy to boost investment and spending and promote economic growth in these sectors. 

Either way, pressure is escalating for rate-setters at the Bank of England to set out how they plan to tackle rising inflation, with investors predicting an interest rate hike in due course. The Bank of England has given some estimations regarding the predicted growth of the UK economy which could be used as a basis for guiding policy decisions. The Bank of England forecasted the economy to grow 7.25% in 2021 but, for example, HSBC has stated that it plainly disagrees with the Bank’s predicted figures. For HSBC, growth of around 6% is more plausible, with this figure being closer to average growth estimations of around 6.5%. If the economy is to remain on track with the Bank’s predictions that overall growth in the third quarter of 2021 will be 2.1%, the economy will need to have surged by 2.1% in September, a surge that is relatively implausible against a backdrop of labour and supply shortages. 

Perhaps the most conclusive thing that can be said about the state of our economy is that it continues to recover from the effects of the pandemic, helped by the hospitality sector, but the impetus built up over the summer months is gradually slowing.  Currently, the economy faces turmoil due to a surge in energy prices and fuel, food and labour shortages. Rising gas and food prices sparked by increased demand have the potential to heighten inflation to undesirable levels, which can lead to a hike in interest rates. This is because increased interest rates are used to slow down the economy via encouraging saving rather than spending. A hike in interest rates will increase the cost of borrowing and will hit those with mortgages the hardest. Higher unemployment is potentially on the cards as a fall in economic output means there is decreased demand for workers.

Report written by Lauren Ainscough

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