The new Tier 4 COVID-19 restrictions, which closely resemble November’s lockdown, raise the chances that the economy stagnates, if not contracts, in the first three months of 2021. If the economy is heading for a double-dip, at least the second leg down will be much smaller than the first. But this is only because activity in some sectors never fully recovered and therefore cannot fall as far this time. And if Tier 4 restrictions keep GDP some 14% below its pre-crisis level, this is of little comfort.
- The new Tier 4 COVID-19 restrictions, which closely resemble November’s lockdown, raise the chances that the economy stagnates, if not contracts, in the first three months of 2021. If the economy is heading for a double-dip, at least the second leg down will be much smaller than the first. But this is only because activity in some sectors never fully recovered and therefore cannot fall as far this time. And if Tier 4 restrictions keep GDP some 14% below its pre-crisis level, this is of little comfort.
- At the very least, the Tier 4 restrictions which came into force in some areas in London and the South East on 20th December for two weeks will prevent the economy from recovering much after November’s lockdown. The impact of the new restrictions will be felt primarily in three sectors “retail”, “transport and storage” and “personal care services”. Together they account for approximately 10% of GDP, with activity in London and the South East making up about a third of the total output of these three sectors. Stopping all activity in those sectors in these areas could subtract up to 3.2% from total GDP. Of course, those closures will only be in force for a third of December. And assuming that these sectors are currently operating at 80% of pre-crisis levels, then the total hit to GDP in December may be closer to 0.8%. Even so, that would reduce our forecast for a rise in GDP of 1.8% m/m in December to closer to 1.0% m/m.
- But the possibility that the Tier 4 restrictions are extended into 2021, or applied to more areas, means that the risks to our Q1 forecast are weighted heavily to the downside. Our current forecast is based on severe COVID-19 restrictions remaining in place in January, and lighter, diminishing restrictions in place in February, March and April before vaccines are widely available from Q2/Q3. But the Secretary of State for Health and Social Care, Matt Hancock, indicated that many regions could remain under the new, even more severe, Tier 4 restrictions until the vaccine is rolled out more widely.
- The uncertainties surrounding all of this are enormous. But if the government opted to place the whole country under the Tier 4 restrictions in January and the economy did not manage to recover much in February and March, then GDP would fall by about 2.0% q/q in Q1. Even if the government asks people to stick to the current rules in January and an easing in restrictions thereafter allows the economy to regain some strength, that may still wipe out the 1.0% q/q rise in GDP in Q1 we currently expect. (See Chart 1.)
- But regardless of whether the economy is headed for a double dip recession or narrowly avoids it, it is how low economic activity is relative to its pre-crisis level that matters the most. An extension of the Tier 4 restrictions into 2021 could keep GDP more than 14% below its pre-crisis levels, until the rollout of vaccines significantly reduces the need for those restrictions. (See Chart 1 again.)
- Overall, if the Tier 4 restrictions become more widespread across the UK in Q1, that would probably cause GDP to shrink again. This would raise the risk of greater longer-term scarring effects on the economy, putting the onus on policymakers to do more. That said, we disagree with the markets’ expectations that Bank rate will be cut into negative territory in the coming months. If it were to act, we think the Bank would prop up demand through speeding up its asset purchases or boosting the uptake of its lending schemes rather than negative rates. (See here & Chart 2.) So the next few months are likely to prove tougher than we thought and the economy may be weaker than we expected. But as long as vaccines are effective and widespread, the recovery should get going again in the second half of 2021.
Chart 1: Illustrative GDP Scenarios (Q4 2019 = 100)
Chart 2: Expectations for Bank Rate (%)
Sources: Refinitiv, Capital Economics
Sources: Refinitiv, Capital Economics
Ruth Gregory, Senior UK Economist, +44 (0)7747 466 451, email@example.com