We think that the government’s roadmap for easing England’s current COVID-19 lockdown will direct the economy back to its pre-pandemic size by Q1 2022. With the Chancellor and the Bank of England unlikely to knock the economy off course with tighter policy, gilt yields are unlikely to rise much further.
- We think that the government’s roadmap for easing England’s current COVID-19 lockdown will direct the economy back to its pre-pandemic size by Q1 2022. With the Chancellor and the Bank of England unlikely to knock the economy off course with tighter policy, gilt yields are unlikely to rise much further.
- The Prime Minister’s announcement today that schools will reopen on 8th March, non-essential retailers will open no earlier than 12th April, indoor hospitality will return no earlier than 17th May and that all remaining domestic restrictions will end no earlier than 21st June (restrictions on international travel may last longer) is broadly consistent with the assumptions we had already built into our forecasts.
- We estimate that the current third COVID-19 lockdown left GDP in January about 9% below the level seen before the pandemic in February 2020. And we forecast that the extra economic activity allowed by the staggered reopening of the domestic economy the Prime Minister has laid out will lift GDP to about 2-3% below its pre-pandemic level in July. (See Chart 1.) With the government now aiming to give all adults their first vaccine dose by the end of July, we think the lockdown easing roadmap will allow the economy to climb back to its February 2020 level late this year and to the same level as in Q4 2019 in Q1 2022.
- Moreover, our view that this crisis is unlikely to permanently lower the level or growth rate of GDP forever more (i.e. there won’t be much long-term economic scarring) means we are forecasting a faster and fuller recovery than the OBR, the Bank of England and the consensus. (See here.)
- Of course, the downside risk is that the government’s four tests on the pace of vaccinations, the level of hospitalisations/deaths, the pressure on the NHS and the occurrence of new virus variants result in the restrictions remaining in place beyond the dates highlighted today. If so, or if households and businesses just remain cautious as sectors open, then the recovery in GDP will take longer. And the longer GDP remains below its pre-pandemic level, the greater the risk of economic scarring.
- But while it’s very unlikely that the government eases the restrictions earlier than announced today, the upside risk is that households and businesses are even keener to get back to normal than we have assumed. Households may use some of the savings they have built up during lockdowns to fund a sizable spending spree on pubs, restaurants, concerts and holidays. If so, the economic recovery would be even faster.
- Either way, the Chancellor and the Bank of England are unlikely to knock the recovery off course by tightening policy. Although the Chancellor may raise the main rate of corporation tax in the Budget on 3rd March, that will probably be more than offset by the cost of extending some of the current support schemes. As such, fiscal policy in 2021/22 is more likely to be looser than currently planned, not tighter.
- And the Bank of England has been stressing since August that it won’t raise interest rates at the first signs of a sustained rise in economic activity or inflation. We think the financial markets have gone too far by pricing in Bank Rate rising above +0.10% by early 2023. Our forecast that it won’t be raised until 2026 implies that, after having risen from 0.30% in late January to 0.68%, there is not that much more upside for 10-year gilt yields. (See Chart 2.) A fast economic recovery and loose policy underpins our forecasts that the pound and FTSE 100 will rise from $1.40 and 6,600 now to $1.45 and 7,500 this year. (See here.)
Chart 1: Level of Real GDP (% Versus February 2020)
Chart 2: Bank Rate & 10-Year Gilt Yield (%)
Sources: Refinitiv, Capital Economics
Sources: Refinitiv, Capital Economics
Paul Dales, Chief UK Economist, +44 (0)7939 609 818, email@example.com