UK economic growth in 2021 was heavily driven by a sharp rebound in household consumption. Increases in consumer spending typically incentivise businesses to expand their investment. As demand for goods and services surged, firms sought to upgrade their machinery and lease larger commercial spaces. However, businesses remain hesitant to commit to large-scale investment unless they believe this expansion in demand is sustainable in the medium term.
At the beginning of 2021, the outlook for consumer spending was highly uncertain. Persistent lockdown measures and concerns over rising inflation made households cautious. Real wages in several sectors had stagnated, and consumer confidence remained subdued.
However, three main factors converged to trigger a dramatic upturn in spending: the release of substantial pent-up "forced savings" accumulated during lockdown periods, historically low interest rates maintained by the Bank of England at 0.1%, and a resurgence in consumer confidence as social restrictions were lifted. Outstanding household deposits had risen significantly during 2020 as consumers had fewer opportunities to spend on services, travel, and leisure.
Furthermore, policy interventions such as the stamp duty holiday stimulated the housing market, leading to a rise in house prices. This generated a positive wealth effect, further encouraging homeowners to increase their discretionary spending. High street lenders also competed heavily, offering cheaper mortgage deals and credit agreements, passing on low borrowing costs to consumers.
Nevertheless, relying on households drawing down their savings to sustain growth has limitations. Once these accumulated savings are exhausted, continued growth in consumption must rely on sustained increases in real disposable incomes. If real wages do not keep pace with inflation, consumer spending is likely to flatten, which could discourage future business investment and worsen the trade balance as domestic production struggles to keep up with imports.
With reference to Extract A, explain two reasons why consumer spending rose in 2021.
