A look ahead to what 2022 may bring – turbulence

As a wit once said, forecasting is extremely difficult, especially about the future. With good reason, as some events occur only once in a century. Yet, we’ve had two of those ‘black swan’ type of events in the last ten years.

So, this is not attempting to forecast what will occur this year; it is more an attempt to understand some of the trends that are currently unfolding and how they may impact in the next 12 months, and whether any new ones emerge or rise to the fore. That said, we can also expect that 2022 will reflect much of what we saw in 2021.

Fallout from the recent past

Brexit issues, Covid-19, and the ongoing effects of monetary loosening through absolute low-interest rates and quantitative easing will continue to reverberate starkly this year. What does this mean? Last year did not see Brexit done. Its consequences with Northern Ireland and the fishing industry and, more importantly this year, the implementation of the complex web of import forms for UK companies of goods coming from the EU which had been delayed. These will have a significant effect in the coming months.

The loosening of monetary policy, with ultra-low interest rates and quantitative easing, has boosted the money supply. Unfortunately, it may now boost inflation due to constrained supply chains as Covid-19 restrictions started to be removed.

Climate and energy

But I think two other factors will rise to prominence and need adding to the list of those that will impact the UK in 2022. The first is the challenge of climate change and the costs of decarbonising the economy. One of the outcomes of COP26 is that the UK signed up to all sorts of pledges on reducing its carbon footprint. However, how it was going to do so and its costs for UK consumers was not explained (see my blog). There was also a range of regulatory and other changes that would impact financial institutions and UK companies that were also not widely discussed.

This will impact UK households and businesses this year in terms of higher bills, particularly for energy, just as these prices rise at their fastest rates in decades. This increase is partly due to the UK’s unique reliance on spot prices for its power, lack of investment in nuclear over the last few decades, and low level of reserves (see recent blog on going nuclear)

Not surprisingly, given the increase in energy prices and inflation, there are already demands for the ‘green levy’ to be axed this year. Expect this pressure point from energy prices to persist at least through the first half of this year. Action on this will have to be taken by the 23rd March 2022 budget from chancellor Sunak, if not before, given political pressure on the Prime Minister from recent political events.

Rising inflation

The second is rising price inflation and the higher interest rates it has already brought. The former will reduce real UK income growth for households, whilst the latter will marginally squeeze their pockets by adding to interest costs. But it’s almost ‘baked’ in that price inflation will exceed wage inflation this year, so that real earnings will fall, as has been the case for most of the last decade since the Financial Crisis, we should remember.

Statistically, the last 10 years have been the worst for real earnings declines since the Napoleonic period. A question has to be, how long can price inflation really rise if real earnings are squeezed and so put downward pressure on household spending and hence economic growth?

Weak economic growth must inevitably lead to weaker future inflation. However, fast money supply growth may allow for higher prices being charged by businesses and acquiescing in higher wage increases because they have the cash to do so.

But that is not a given because money supply growth is already falling. A broad measure shows that money supply (M4) grew 6.9% in the 12 months to November 2021, down from a 15.4% peak in February 2021. But the earlier increases in money supply are already reflected in the inflation rates that we’re seeing.

Although caused by supply chain issues, abundant money helped support its emergence. But the trend of money supply growth suggests that price inflation and growth will fall sharply in 2023.

Pressure on income

Debt interest payments for companies will be higher than otherwise, at a time when there will be slowing economic growth and the requirement to start to pay back the various government support schemes they drew on during the worst of the pandemic over the last couple of years.

Farmers’ payouts from the UK government will be about 47% lower than they received under the EU’s common agricultural policy. Fishermen have not got what they thought they would. And they are facing enormous challenges over access to selling their catches without giving access to their fishing grounds, where the EU was their biggest market.

The UK’s Office for Budget Responsibility (OBR) calculated in November last year that the cost of Brexit (4% of GDP) in the long term will be twice the cost of COVID-19 (2% of GDP) in the long term.

It’s worth pointing out an immediate issue: the UK has started implementing the system of customs declarations for goods coming in from the EU for the first time since we formally left in January of 2021, which will impose additional costs and burdens on UK importers. So, I expect this to be a central theme for this year.

Additional factors in play

There are several other issues that will be in play this year:

Will financial markets rebalance after enormous increases in most countries’ equity prices last year?

The question is not if negative bond yields will persist, but how negative can they be with inflation rising ahead of interest rates? Will negative real returns for bonds continue?

What impact will this have on the financial market?

COVID-19 meant an unequal global economic recovery last year due to unequal distribution of vaccines – so emerging markets are likely to remain sluggish this year. Will higher rates lead to even worse outcomes?

Geopolitical issues are likely to persist in Europe, in the Middle East and the South China Sea.

Although the UK economy may grow this year between 3 to 4% according to the consensus, after about 6 1/2 per cent last year, and a fall of around 10% in 2020, the amount of new money for the government’s ‘levelling up’ agenda is not great.

We can’t predict these events, but we can monitor them, have plans for various scenarios, and try and react nimbly and sensibly.

As was said in a song, ‘there are more questions than answers, and the more we find out, the less we know’.