UK Economy: Stagnation this winter?

The Covid-19 pandemic has led to a severe drop in economic output in the United Kingdom. The lockdown of the economy has been somewhat stricter and some containment measures have remained in effect longer than in several other countries. As elsewhere, travel, tourism, hospitality, entertainment and many other sectors of the economy were hard hit. After gross domestic product (GDP) fell by 2.5 percent in the first quarter of 2020 (that includes the month of March when the lockdown started), it is estimated to have fallen by 19.8 percent in the second quarter according to the Office for National Statistics. In the first half of 2020, the recession in the United Kingdom was more pronounced than in most other advanced economies. In particular, private consumption dramatically decreased by 23.6 percent. Investment was reduced by 21.6 percent. According to the GDP monthly estimate of the  Office for National Statistics, the recovery started in May with a small increase of 2.7 percent. The reopening of the economy accelerated in June. Strong economic growth is recorded for June and July (+9.1 and 6.4 percent). In August, the recovery was much slower at only 2.1 percent. The highest contribution came from the accommodation and food services sector, which will not be repeated for the subsequent months. The level of the gross domestic product remained 9.2 percent below the level observed in February 2020. The data for September are not yet published, but only a small positive growth rate should be expected. For the third quarter ranging from July to September, this will still result in a fairly high growth rate.

However, current developments suggest that we will observe only minor economic growth in the fourth quarter of 2020. Purchasing Manager Indices (PMIs) for both the manufacturing and the services sector recently decreased. As I had expected, after an initially strong rebound in the summer, the recovery will be much more modest in the winter. In addition, one can say that a second wave of the Covid-19 pandemic has started with a fast growth of Covid-19 cases. Currently, it is difficult to assess how the situation will develop and how many people will be hospitalized. It seems likely that the winter will be quite hard for the people and society and result in only very small economic growth rates or stagnation. I would not exclude a small recession in the fourth quarter of 2020 and the first quarter of 2021, but it is not my baseline at the moment. Unemployment will almost surely increase in the coming months. Aggregate demand and the demand for workers will be subdued. In addition, because of the various uncertainties surrounding the pandemic and Brexit, firms will be reluctant to hire.

 

Various large fiscal and monetary policy measures support the economic recovery and cushion the effects of the crisis on the labor market. I expect that the budget deficit will be around 20 percent of GDP in 2020 and perhaps around 10 percent in 2021. Inflation will remain modest but in the medium-term, I think that inflation will rise above the levels observed before the outbreak of the pandemic. The unemployment rate will almost surely further increase in the coming months. For the whole year of 2020, I expect a severe recession and a contraction of the economy of perhaps 9 to 10 percent and unemployment will considerably increase. This will hopefully be followed by a relatively strong rebound of 5 to 7 percent in 2021. In a more dramatic scenario that is increasingly likely (in particular, if the second wave of the pandemic gets larger and persistent), the contraction in 2020 will be at around 12 percent and the recovery in 2021 at a modest rate of around 3 to 4 percent. As I mentioned above, such forecasts are obviously associated with a high degree of uncertainty. In addition to the uncertainties surrounding the pandemic, it is still not clear how exactly Brexit will occur and whether it will cause additional risks to the economy – at least in the short term. Recent developments suggest that turbulent weeks lie ahead of us. At the global scale, worldwide tensions could increase – especially between the United States and China.

While I use several models in my forecasts, my published numbers are also strongly influenced by my personal experience and judgment.

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