Poppy Bramford, Policy & Public Affairs Manager,
Herefordshire & Worcestershire Chamber of Commerce
Despite some worrying GDP figures for Quarter 1 2020, the Office for Budgetary Responsibility (OBR) and the Bank of England have published scenarios which characterize the economic impact of the Coronavirus as a frontloaded, short, sharp shock, followed by a relatively swift recovery.
Return to work outputs
Although Britain has slowly started to return to work this week, the OBR is still penciling in a 35% decline in output in the second quarter of 2020. Figures released last week demonstrated that GDP declined by 2% (percentage change on last quarter) during Quarter 1 (Jan – Mar) 2020. At the peak of the Global Financial Crisis, GDP contracted by 2.10% during Quarter 4 2008. Unlike during the Global Financial Crisis, the OBR’s scenario estimates that the economy will benefit from a rapid bounce back, with a GDP increase of 27% in Q3 2020. Unemployment is expected to peak at 10% in Quarter 2 2020, before falling to 8.5% in Quarter 3 and then to 7.3% in the final three months of the year. The results of the OBR’s scenario depend heavily upon the assumption that a three-month lockdown on economic activity will be followed by a gradual return to normal, over the subsequent three months.
It is important to note that the OBR has published a scenario and not a forecast. This scenario is based on the illustrative assumption that economic activity will be heavily restricted for three months and then will gradually return to normal over the subsequent three months.
Bank of England forecast
The Bank of England shares the OBR’s view that the economy will recover quickly from the business activity restrictions associated with the coronavirus, anticipating that the lost ground will be made up by the end of next year. The Bank of England predicts a “V shaped” crash and recovery. The Bank also expects unemployment to peak just below 10%, followed by a decline to similar levels experienced this year. Although the Bank’s forecasting is not unrealistic, it is optimistic, as it assumes that the government is able to contain the virus spread and prevent a second wave of coronavirus infection. Under the Bank’s assumptions, the economic damage will be worse if restrictions remain in place longer than expected. Every extra fortnight of lockdown and support measures in the UK, and around the world, costs 1.25% of GDP, although this will have little effect on how much output has been recovered in three years’ time.
Quarterly Monetary Policy Report
The Bank of England’s quarterly Monetary Policy Report has been produced alongside an interim Financial Stability Report. Together, they provide a scenario for the path of the UK economy in light of Covid-19 and assess the financial system’s resilience to that scenario. Under the assumptions made, the Bank of England warn of some longer-term reduction in the supply capacity of the economy. This is due to lower investment and reduced innovation. It is worth noting however, that the Bank anticipates that the so-called scarring effect will be relatively small. The report suggests that CPI inflation is likely to fall to around zero at the end of this year, in part reflecting the spare capacity in the economy but also the fall in the price of oil.
The Financial Stability Report is somewhat reassuring, demonstrating that banks are in a far better position that they were prior to the GFC. Much expanded capital buffers, due to a regulatory shift post Global Financial Crisis, means that Banks have the capacity to withstand the potential losses projected by the Monetary Policy Report. It seems the banking sector has enough capital to withstand a very severe shock.
Recovery
Both the OBR and the Bank of England are quick to caveat their publications with a disclaimer which states that the timing of the recovery will depend to a significant extent on how long social distancing and support measures are in place. The Bank of England is quick to point out that there are many possible scenarios and that this is just one of many plausible paths. They also note that the speed of the recovery will be affected by how households and businesses respond once measures are lifted. International examples suggest that even where lockdown measures have been phased out, consumers continue to practice social distancing even after the formal rules are relaxed. At present, payments data point to a reduction in the level of household consumption of around 30%.
With state spending soaring and tax revenues badly affected by the lockdown of much of the economy, the OBR said it was expecting the government to borrow £298.4bn in 2020-21, up from £273bn at the end of April and £55bn at the time of Sunak’s budget on 11 March. If the OBR’s forecast proves correct, then government borrowing would reach more than 15% of GDP, a post-war record. As government continues to demonstrate that it is committed to providing financial support to businesses to weather this storm, the next stage in the restart process will demand more than financial packages. Government needs to ensure that the return to work and subsequent recovery prevents a second wave and ensures this hiatus in economic activity is temporary.
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