Aftermath?
We have just witnessed the largest hit to the economy the UK has ever seen and the landscape is unrecognisable from a year ago. Covid-19 and the initial lockdown caused a 26% fall in GDP, a larger decline than almost any other major economy. The unprecedented fiscal response has helped limit the damage to the economy thus far but will present a future challenge for government and society. It has not been helped by the fact that a second wave of infections has prompted further lockdowns across the UK over the winter.
The £210 billion borrowed in the first six months of the financial year-to-September 2020 is almost four times the total borrowed in the whole of the previous financial year and the budget deficit is set to hit the highest level since World War II. The monetary response has been just as significant, with interest rates cut to the all-time of low of 0.1%, £100bn of asset purchases carried out and a further £150bn (at least) is set to be undertaken over 2021. The Bank of England has actively considered negative rates and the total quantitative easing program stands at £745bn.
As if it could be worse. Brexit remains unresolved at the time of writing and with time running out on trade talks, there are renewed fears of a no trade agreement. The Covid-19 crisis has hopefully strengthened the resolve of all sides to reach an agreement, in order to avoid even more disruption and damage to the respective economies.
Assuming a trade deal of some kind, inflation looks likely to remain low for the short term due to temporary tax cuts and weak demand, although inflationary pressures are likely to start to build once the recovery restarts. If a deal is not reached and the UK is left to trade under WTO rules, economic growth would be weaker over both the short and long term. An increase in tariffs and a weaker sterling are likely to result in upward inflationary pressure.
One of the drivers of this will be the enduring low interest rate environment, necessary to support the economy. Despite the last-minute extension of the furlough scheme, a likely rise in unemployment, the restrictions to contain Covid-19 and Brexit (whatever it ultimately looks like) will weigh on growth and we therefore expect further monetary stimulus in 2021. This will take the form of further quantitative easing, with negative interest rates a last port of call. The Bank of England seems concerned that the adverse impact of negative rates on banks profitability could mean they restrict lending, making them counterproductive and we therefore think they are unlikely in 2021.
Ultimately, the state of the economy is being held to ransom by the spread of Covid-19 and will continue to be until the virus is brought under control.
Under pressure
The initial economic recovery post ‘first’ lockdown was very strong as the economy reopened but many of the ‘easy wins’ passed and recovery slowed. The second wave of infections and resulting lockdown measures have subdued the outlook for 2021 even further. As well as slowing the recovery, the longer containment measures are in place, the greater the risk of high unemployment and business failure leads to what the Bank of England referred to as ‘contagious pessimism’ and permanent economic scarring. On a positive note, the continued willingness to respond to the fluid environment with more fiscal support when required is positive but we fear is ultimately unsustainable through 2021.
One of the bright sparks in the economy during 2020 has been consumer spending. The likely tapering of fiscal support, rising unemployment and continued containment measures will weigh on consumers’ ability and willingness to spend in 2021. The job losses we are likely to see in 2021 are likely to be concentrated in lower-earning sectors, and low-income households tend to spend a higher share of their income. This means the effect on consumer spending, which has actually held up relatively well thus far will be especially negative.
Ultimately, the state of the economy is being held to ransom by the spread of Covid-19 and will continue to be until the virus is brought under control, with Brexit a potential cause of further disruption. The upside is reliant on scientific advances– most notably an early implementation of a vaccine but also increased testing capacity and enhanced therapeutics.
The recent positive news on a likely vaccine does present significant upside. An effective COVID-19 vaccine would dramatically improve the economic outlook. It should allow GDP to rise to its pre-virus level faster than otherwise and mean that the unemployment rate peaks at a lower level. The scale of impact in 2021 largely depends on when it becomes widely available. Also, while in theory it would reduce the need for more quantitative easing and/or negative interest rates, in reality we doubt the Bank of England would reverse asset purchases or raise rates for many years.
