UK Economy: A hard winter

The Covid-19 pandemic has led to a severe drop in economic output in the United Kingdom. In the spring, 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 already much slower at only 2.1 percent and was mainly driven by accommodation and food services. Overall, the economic growth rate in the third quarter ranging from July to September was at 15.5 percent. This implies that the level of the gross domestic product remained 9.7 percent below the level observed in the end of 2019. Private consumption considerably increased (+18.3 percent), but there was also on a surprisingly high (at least for me) growth rate in private investment (15.1 percent). Imports grew faster than exports which reduced the trade surplus that has emerged in the end of 2019 and increased in the first half of 2020.

While it was clear that the fast initial recovery would considerably slow down in the fall, the second wave of the pandemic and the subsequent lockdown measures has led to a more abrupt slowdown and a reversal of the recovery. Current developments suggest that we might observe a contraction of the economy in the fourth quarter of 2020 (perhaps around minus 2 percent). It seems likely that the winter will be quite hard for the people and society. Unemployment will almost surely increase in the coming months. In addition, there are not only various uncertainties surrounding the pandemic, but also regarding Brexit. On the bright side, one has good reasons to hope that effective vaccines will be increasingly available in the course of 2021.

Various large fiscal and monetary policy measures support the economic recovery and cushion the effects of the crisis on the labor market. One may expect that the budget deficit will be around 20 percent of GDP in 2020. Probably, some fiscal adjustment measures – most likely a combination of tax increases and spending cuts – will be adopted in the near to medium term. 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.

For the whole year of 2020, I expect a severe recession and a contraction of the economy of around 11 to 12 percent. This will hopefully be followed by a solid rebound of around 5 percent in 2021. I expect that Brexit will have some negative effects on the UK economy next year. In a more dramatic scenario (in particular, if the current wave of the pandemic is persistent and lasts until the spring), the recovery in 2021 will be more modest at around 3 to 4 percent. The unemployment rate could increase to more than 7 percent next year. For the next months, the extension of the Job Retention Scheme until the end of March 2021 will prevent a fast increase in unemployment.

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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