London’s economy: from challenges to opportunities

Written By:

William Matthews, Knight Frank

03 Feb 2021

8 minutes to read

Categories: London Report The Case for Cities

• While some cities initially appeared to be faring better than others in their fight for economic recovery, few in the West at least have come out consistently and decisively ahead
• 2021 is forecast to be a strong year for IPO activity, and London’s stock markets remain a prestigious location for listing
• Although the shape of London’s financial sector may be in flux, its scale and leadership are not in doubt

At the start of 2021, London’s economy faces two key considerations, one global, and one domestic in nature, but each with the potential for long-term significance. What should we make of the dual impact Covid-19 and Brexit, and how will London’s economic outlook be affected?

1. The prolonged threat of Covid-19 and the implications of lockdown 3.0

The government’s decision to impose tougher lockdown restrictions on the UK for a period of at least seven weeks in early 2021 has delayed, rather than eliminated, a rebound in London’s economic activity this year. In the short term, there are clear implications for sectors such as hospitality and retail, which are most directly impacted by a reduction in footfall. As in previous lockdowns, other service sectors will fare relatively better, as they are more readily adaptable to remote working, but for most organisations in London, the mass return to work will inevitably be postponed.

The outlook becomes more optimistic from the middle of 2021. Much of the negative economic impacts of lockdown periods will be rapidly reversed once restrictions are eased, as evidenced by the record growth rates experienced in mid-2020 when similar restrictions were eased. Additional fiscal support, such as Chancellor Sunak’s latest £4.6 billion package for UK businesses, will find its way into the economy. Indeed, the relatively successful combination of remote working and furlough payments has ensured that London’s unemployment (6.9% in Q4 2020, equal to the long-term average), while notably higher, has moved by a comparatively modest amount relative to the much larger volatility in economic output.

The consequence of recent stimulus measures is that, unlike a normal recession, once restrictions ease, employees will, in the main, have jobs to return to. And government support is only one part of the equation: the Bank of England has already cut base rates to just 0.1%, and injected £895 billion of quantitative easing (double that unleashed during the global financial crisis). Further measures cannot be ruled out.

If nothing else, the Covid-19 pandemic will ensure that interest rates in the UK and other large economies remain low for years to come, adding to the weight of capital needing to be actively deployed globally, and benefiting asset classes such as real estate that act as an inflationary hedge.

Read: Why prime headline rents are set for continued growth

The pace of vaccine roll-out holds the key to recovery. Globally, while some cities initially appeared to be faring better than others in their fight for economic recovery, few in the West at least have come out consistently and decisively ahead. Despite suffering more cases than in much of Europe, the UK, with its significant head start in vaccinations, could see a more rapid return to economic normality than in some European economies where immunisation programmes are at earlier stages. The UK has now licensed three major Covid-19 vaccines for use, and has an ambitious plan to vaccinate around 15 million of the country’s most vulnerable people by mid-February, and the majority of those over 50 by the end of March.

“London will see the strongest GDP growth of the large European cities.”

Consequently, signs of cautious economic optimism are still to be found. The latest consensus forecasts compiled by HM Treasury¹ show UK GDP expanding at 4.4% in 2021, an impressive pace, albeit not sufficient to make up for all of 2020’s lost ground. Longer term, forecasts from Oxford Economics suggest that London will see the strongest growth of the large European cities, with a per annum expansion of close to 2.7% over the next ten years – despite the impact of the pandemic, and the readjustment to a post-Brexit environment.

2. London’s new role outside the EU

The agreement of a UK-EU trade deal in late 2020 averted much of the disruption to goods flow feared by some in the event of a no-deal scenario but offered little detail on the UK’s much larger trade in services with EU countries.

The next goal: a memorandum of understanding on financial services. As part of its withdrawal from the EU, the UK no longer enjoys financial services passporting rights – the ability to easily undertake work in other EU countries without a establishing a presence there. This is significant, given that EU member states account for almost 35% of UK financial services exports.² In addition, the UK’s ability to diverge on financial services regulation means that it is unable to rely on being granted “equivalence” by the EU.

As a result, UK financial services businesses no longer have automatic, unfettered access to the EU market, and London’s myriad financial specialisms have come under the spotlight as it has gradually become clear which elements in practice may be at risk. For example, early reporting suggested that around €6 billion of daily trading in European shares moved from London to other European exchanges at the start of January. Nevertheless, there is evidence that much of the impact has already been priced in, with neither a significant movement to financial indicators such as Sterling, nor a notable increase in businesses announcing relocation plans.

The UK and EU are seeking a memorandum of understanding on financial services by March 2021, which would create a framework for co-operation on financial services, and seek to ease some of the current barriers to trade in financial services. Until that agreement is met, however, and in reality for some time to come, there is likely to be a period of ongoing practical readjustments to where certain types of activity are undertaken.

While the end of the transition period has undoubtedly raised some challenges for London’s financial services sector, there are also new opportunities emerging. For instance, no longer impacted by a 2019 EU ban on trading in Swiss shares, this market will be able to resume in London. Meanwhile, 2021 is forecast to be a strong year for IPO activity, and London’s stock markets remain a prestigious location for listing. According to recent research from EY, London remains in third position, behind US and Chinese markets, for funds raised, and was responsible for 40% of capital raised by European companies in 2020, despite the impending end to the transition period.

A period of tweaking regulation, rather than ripping up the rulebook awaits. Some have suggested that there may be significant scope for deregulation in a post-EU environment, with the aim of attracting new business in the process. However, any deregulation will have to tread a fine line between providing useful competitive advantages and appearing unnecessarily antagonistic to EU regulators. In practice, this could lead to less overtly market-specific deregulation, and a greater focus on aspects such as looser pay and bonus caps.

“Green finance is one area in which London will seek to strengthen its position.”

Regulation may also increase – and bring with it new benefits. Green finance is one area in which London will seek to strengthen its position, and it will be supported by government intentions to introduce mandatory climate change disclosures across the UK economy by 2025, with many of the measures in force by 2023.³

Read: London investment set for a rebound in 2021

These requirements will apply to companies listed on the London stock exchanges, making these companies attractive from the perspective of the increasing number of investment funds that are required to consider green factors in their decision-making and asset holdings.

Structural change will be subtle, but powerful. Longer term, the biggest changes to London’s economy are unlikely to be Brexit-related, but rather a function of its constant evolution over time. While some stages of this process come with a clear announcement – the 1986 Big Bang deregulation of the City of London being the archetypal example – most do not. The tech sector growth of the past two decades has been more gradual, but no less significant, with tech firms increasing their share of total office space take-up to 14.8% between 2018 and 2020, second only to finance and banking (17.7%).

Similarly, London’s growing importance in life sciences and dominance in innovation more broadly cannot be traced back to a single event, but rather a confluence of supporting factors – necessary funding, world-class education and international talent, to name a few. The consequence of such evolutionary change for London’s economic outlook is a period of greater balance and less of a reliance on a particular sector.

Read: London – city of innovation

Ultimately, much is still to be agreed over the coming months. In particular, it remains too early to identify the precise changes that London’s financial markets will undergo in the coming years, although three things are clear:

1. Change will be an evolutionary process, allowing businesses vital time to make strategic decisions, rather hasty reactions to the revolutionary disruption once feared.
2. While the media focus to date has favoured the negative aspects of London’s new position, significant and tangible opportunities are emerging too.
3. Although the shape of London’s financial sector may be in flux, its scale and leadership are not in doubt.

Read: The evolution of global cities

1. Gov.uk

2. The City UK

3. HM Treasury