Thursday 20 May 2021 7:00 am

Furlough and unemployment will keep inflation figures down and give Rishi Sunak breathing room

Jonathan Gillham is the Chief Economist at PwC

Fresh statistics have shown inflation in the UK has more than doubled in the last month. This has dominated the headlines as many economists fear spiralling inflation. However, the reaction is The news from the ONS that UK inflation has more than doubled in April has generated concerned headlines. Such a reaction is somewhat inevitable. As we come out of the lockdown, inflation will naturally tick up. But does it really pose a risk to the economy?

It’s important to get a sense of perspective. The Bank of England forecasts inflation to peak at 2.5 per cent in 2021 Q4 and then return to target for the next couple of years. Coming out of the financial crisis, average annual CPI was 3.3 per cent in 2010 and 4.5 per cent in 2011. It did not settle below the Bank’s target of 2 per cent until 2014.

For our current predicament, the Bank has given us a modest forecast for the next two to three years and that latests news largely shows we are merely meeting this target. Higher inflation in the US, with CPI at 4.2 per cent, paints a different picture to Britain after a far greater amount of stimulus.

There are clear inflationary pressures at the moment, but we could be looking at a low inflation recovery. We’ve seen GDP perform better than expected in the last few months as businesses and consumers have adjusted to lockdown. Meanwhile, the prospect of a mini consumer spending boom this summer is anticipated by many (including the Bank), as vaccine roll-out continues and restrictions on physical retail and the hospitality sector are easing.

However, the economy is still being propped up by large amounts of Government support and through the Autumn, this will start to unwind. The furlough scheme has been a remarkable success, but at the same time it has created a stasis in the labour market. Expectations of a return to work in September are high – ONS data suggests that only 10 per cent of furloughed workers are searching for jobs.

To expect a completely smooth transition of furloughed workers back into their old jobs is optimistic. It’s unlikely we will see a “big bang” where employment levels fall off a cliff the day the scheme ends but we can expect some disruption. Employees might find their job roles changing, they may be offered reduced hours and a proportion will unfortunately find that their job no longer exists. 

In addition, many workers can expect subdued wage growth over the next two to three years as businesses exercise caution and rebuild the cash reserves they needed to dig into to remain operational at the worst points of the coronavirus crisis.

This disruption is underpinned by a key problem the UK economy was experiencing prior to the pandemic – the positive condition of the labour market was overstated. High employment levels gave policy makers a false sense of security. Structural problems such as low wage and productivity growth were deep-rooted and many households were taking second (or even third) jobs to maintain income levels.  

This underlying fragility has only been compounded over the last 12 months and lower income households, who felt these effects most acutely in the wake of 2008, could be more cautious with their spending and saving habits. 

There are strong push and pull factors on both sides. Ultimately, however, they are more likely to prevail in a lower than usual inflationary scenario for an economic recovery, meaning that inflation driven pressure on the Bank of England to raise interest rates in the next 2-3 years will be limited.  

There are still going to be bumps in the road and the latest figures are a product of that. In the short term, it is unlikely we will have a smooth inflationary path. Retail discounts seen early in 2020 have been wound down, global energy prices are rising, supermarket competition that kept food prices low is tailing off. Businesses are feeling increased pressure to pass on higher raw material and freight costs to consumers. These factors are now feeding irregularly into the monthly data. 

There are challenging issues to be addressed in the labour market, but the lower inflationary pressures should give policymakers and businesses more space to focus on issues such as the skills agenda, achieving net zero and levelling up – all of which will help build economic resilience for the future. 

City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.