UK business investment expected to rebound strongly in 2022

UK business investment is expected to rebound strongly in 2022 because of a generous government tax incentive and the need to upgrade assets that have been neglected as a result of uncertainties related to Brexit and the pandemic.

Most economists expect capital expenditure to grow at its fastest pace in years in 2022, helping — along with rising consumer consumption — to drive economic growth. But many predict that the two-year incentive that expires in March 2023, known as the super-deduction, will only bring forward some investment and not help create much new spending.

As a result, they forecast that the policy might be insufficient to make up for the lost ground.

Business investment would be a “major growth driver” in 2022, said Thomas Pugh, an economist at tax consultancy RSM UK. With companies holding £140bn more cash than before the pandemic and a large backlog of projects likely to have accumulated during the lockdowns, they are “in a good position to invest”, he said.

The Omicron coronavirus variant might threaten the expected rebound, even if new restrictions are not imposed, because of heightened uncertainty.

But if Omicron does not disrupt production and consumption patterns, many economists expect companies to take advantage of the super-deduction to invest.

The measure allows businesses to cut their tax bills by 25p for every £1 they invest in plant and machinery. Steffan Ball, chief UK economist at Goldman Sachs, said this was one of the most generous government investment incentives globally and that it was well-timed because physical assets had aged following years of under-investment.

In line with the double-digit growth forecast by the Office for Budget Responsibility, the fiscal watchdog, Pugh expects capital expenditure to grow 10 per cent next year, which he said “will set the economy up for stronger sustained growth in the future”.

Economic surveys echo this optimism. The Bank of England’s regional agents assessment of business investment intentions rose to its highest level in 14 years in the third quarter. Over the same period, the share of businesses planning to invest in plant and machinery rose to the highest proportion in 33 years, according to a survey by the CBI business group.

Line chart of Bank of England agents' score showing companies' investment intentions have risen to a 14-year high

Chief financial officers from UK businesses surveyed monthly by the Bank of England expect Covid-19 to dampen business investment by 8 per cent in the final quarter of this year, but this drag is expected to reverse from the second quarter of next year.

Companies’ needs and government policies, which also include investment in infrastructure and skills, “should end up being very positive for productivity and business investment”, said Ball. This would be crucial if the government was going to deliver on prime minister Boris Johnson’s pledge to create a “high-wage, high-skill, high-productivity economy”.

However, the rebound comes from historically low levels and some economists said it would still leave the UK lagging behind other advanced economies.

Line chart of £bn in 2019 value (taking into account an ONS error) showing UK business investment has underperformed the trend

It is difficult to overestimate the lack of UK capital expenditure growth, compared with the wider economy, its historical trend or other countries.

Up to the third quarter, UK business investment was 10 per cent below the pre-pandemic level. In contrast, the wider economy was 2.1 per cent smaller. UK capital expenditure was also well below the level in the US, France and Italy, where it has exceeded levels recorded in the fourth quarter of 2019.

The UK’s underperformance was in part because of “the disappointing pace of the initial recovery” after the pandemic, which had reduced the incentives for businesses to invest, said Andrew Goodwin of Oxford Economics. But it also reflected a lack of investment since 2016 amid high Brexit-related uncertainty.

In the UK, business investment in the third quarter was still about 10 per cent below the level in the second quarter of 2016, when the country voted to leave the EU. Over the same period, it grew by 8 per cent in the eurozone and by nearly 20 per cent in the US.

Line chart of real index rebased Q2 2016=100 showing UK business investment lags behind other advanced economies

Ball said there were some “silver linings” to the disappointing data, particularly the pandemic-induced shift towards greater business digitalisation that generated efficiencies across the economy. Official data show that, in contrast with the decline in overall business investment, UK corporate spending on intellectual property products, such as software and research and development, was up in the third quarter, both compared with its pre-pandemic and pre-Brexit referendum levels.

Yet, the longer-term outlook for business investment remains uncertain. Brexit worries have not disappeared and many economists said the growth expected over the next year would not persist.

Businesses “still have to worry about the UK-EU trade deal unwinding in the event of an increase in tensions over Northern Ireland’s borders”, said Gabriella Dickens, economist at Pantheon Macroeconomics. She also noted that official data on corporation tax receipts suggested that super-deduction claims were accruing more slowly than the OBR expected.

Column chart of Brexit as a source of uncertainty for own business, % of respondents showing Brexit remains a key of factor for UK companies

Yael Selfin, chief economist at KPMG UK, said the super-deduction would not “lift the level of investment permanently” and that capital spending would be “weaker than it would otherwise have been from 2023 onwards”.

Tony Danker, CBI director-general, said the incentive “is a welcome catalyst, but a one-hit wonder isn’t enough to make up for four decades of underperforming business investment”. He added that the rise in corporation tax from April 2023 would mean that “business investment will continue to lag other advanced economies”.

Danker also called on the government to build on the policy with targeted incentives in areas such as green technology to encourage sustained investment. “A booster for growth is needed to protect and build on our recovery,” he said.

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