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July 7, 2023

How a rapid post vaccine recovery, labour market tightness and shifting consumer behaviours created a perfect inflationary storm

On Wednesday, 5th July, I had the privilege of joining Professor Sir Charles Bean, (former Monetary Policy Committee and OBR Budget Responsibility Committee member), Stephen King (Senior Economic Adviser to HSBC) and Dr Sushil Wadhwani CBE (former MPC member) in giving evidence to the Treasury Select Committee. The session examined the Bank of England’s inflation forecasting record and recent actions, as well as how inflationary pressures can be reduced going forward.

All on the panel echoed what has by now become a widely accepted view, which is that the Bank underestimated the magnitude of the inflationary threat. The Bank itself has acknowledged shortcomings, launching an inquiry into its inflation forecasting.

In addition to scrutinising the Bank’s actions, preparing for the session proved a good opportunity to examine Cebr’s own inflation forecasting track record. While we of course haven’t always gotten the projections exactly right, our broad view that inflation would pick up in mid to late 2021 and remain well above target for a prolonged period has proven correct. Further confirmation that our inflation expectations have closely aligned with reality came in the form of an award from FocusEconomics, which recognised Cebr as one of the top three forecasters for UK inflation in 2022/23.[1]  

Despite the welcome accolades, some introspection does seem in order. So with the benefit of hindsight, and in order to draw lessons for future forecasting work, I examine some of the big calls we got right, as well as some developments that we missed.

The single biggest call we got right is the rapid pace of post vaccine recovery. On 1 January 2021, a couple of months after the first serious good news on the vaccine research front, Cebr published its top 10 predictions for the year ahead. At number one was:

As vaccinations spread, much of the world will start to return to normal. Indeed, pent up demand could create price rises and shortages in many areas, especially in services where supplies might be limited.

In the same publication, we said that we expect to see UK GDP growth of around 8% in 2021 – not far off from the actual figure of 7.6% and much closer than the consensus forecast of 5.3%.[2]

Another big piece of the inflation story is labour market tightness. Here, our forecasting record is mixed.

During the early Covid lockdowns, a number of the UK’s foreign-born workers moved back to their countries of origin, and we were always sceptical about the extent to which they’d come back. The exact number is difficult to pin down, but estimates suggest that the first wave of Covid saw as many as 1.3 million people born abroad leave the UK.[3] Had the pandemic passed in a matter of months, it is likely that many more of these people would have come back and filled their previous roles. However, as restrictions and lockdowns stretched over the quarters and even years, Cebr made the largely correct assumption that many of them would continue to live abroad permanently, even if they had initially thought of their departure as temporary.

What we did not get right initially in terms of the labour market, is the impact the end of furlough would have on unemployment. In January 2021, we were expecting unemployment to average 6.6% over the year, far above the actual figure of 4.5%. It was only in mid-2021 that we took the view that the end of the furlough scheme wouldn’t lead to a big spike in unemployment, partially due to the vacancies created by those leaving the UK, but also due to the tapered way in which furlough ended. In its final phase, the grant covered 60% of wages with employers obliged to top up 20%. At that point, we took the revised view that most companies with staff still on furlough would bring them back to work following the end of the scheme. It seemed unlikely that businesses would have been willing to pay the wage top up had they not had the confidence that they could bring furloughed workers back.

We also did not anticipate the collapse in public sector productivity, which post pandemic has on average been 8.5% lower than pre pandemic, and which is an important factor further contributing to a tightening labour market.[4]

A further point which we got broadly right relates to the resilience of consumer spending. We paid close attention to the build-up of Covid savings and aimed to reflect changes in consumer behaviour since the onset of the pandemic in our modelling.  

In April 2020, Cebr estimated that in the second quarter of that year, households would accumulate £23bn of excess savings due to restrictions on spending opportunities.[5] We updated these estimates throughout the pandemic and while we were by no means the only forecaster to do so, we somewhat stood out in our assumptions regarding people’s willingness to spend those savings to maintain their lifestyles in face of higher prices and a deteriorating economic outlook.

In light of the pandemic, spiralling costs of living and a war in Europe, the 2020 to 2023 period has seen several bouts of declining consumer sentiment.

Unusually, this pessimism has not translated into a significant consumer expenditure slump, further contributing to inflationary pressures. This is something Cebr picked up early. A further two predictions in our Top 10 for 2021 centred on increased demand for travel and eating out.

We believe that the reasons behind this disconnect in confidence and expenditure are twofold. Firstly, as mentioned earlier, employment levels have remained strong and households are less likely to change their behaviour if they don’t feel the downturn on a personal level, e.g. through job loss. Secondly, anecdotal evidence suggests that the pandemic has made some consumers more focused on their immediate quality of life, which they are happy to prioritise at the expense of saving for the future. This shift in mentality may have been reinforced by the succession of crises that the global economy has grappled with ever since the financial crisis in 2007/08. Large economic shocks have been so persistent that the term ‘permacrisis’ was the Collins Dictionary’s 2022 word of the year.[6]

Paradoxically, the steady flow of bad news may have made consumers more likely to tune out economic warnings about the future and more focused on living, and spending, in the moment.

In terms of what lies ahead for inflation, at Cebr we believe that the worst is behind us, with price rises set to gradually cool down. Still, the road to target inflation is set to be a long one – we don’t expect to see inflation at target level until late 2027. As a result of the Bank of England’s delay in tightening monetary policy, it is likely that the drop off in inflation will come at a greater cost in terms of economic growth. Cebr expects UK GDP to expand just 0.3% and 0.4% in 2023 and 2024, respectively, including a short and shallow recession over the winter. This forecast, however, is conditioned on a relatively lower peak in interest rates than currently predicted by market participants. Should the Bank feel coaxed into giving in to current market expectations – perhaps in order to restore some lost credibility – and raise rates to well over 6% in order to bring inflation back to target, we might very well see a more pronounced downturn.    

[1] Focus Economics

[2] FocusEconomics’ Consensus Forecast Major Economies – Jan 2021

[3] Economic Statistics Centre of Excellence (ESCOE)

[4] Office for National Statistics – Public Services Productivity

[5] Cebr

[6] Collins Dictionary

For more information, please contact:

Nina Skero, Chief Executive
Email: nskero@cebr.com, Phone: 020 7324 2876

Cebr is an independent London-based economic consultancy specialising in economic impact assessment, macroeconomic forecasting and thought leadership. For more information on this report, or if you are interested in commissioning research with Cebr, please contact us using our enquiries page.

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