Three lockdowns, two recessions, one big recovery - Capital Economics
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Three lockdowns, two recessions, one big recovery

UK Economics Update
Written by Paul Dales
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  • The third lockdown to contain COVID-19 means that the economy will start the year in recession and the recovery will be delayed again. Even so, by expecting the economy to regain its pre-crisis level in Q2 2022 and to avoid major long-term scarring, we remain more optimistic than most forecasters.
  • We estimate that the third COVID-19 lockdown, which in England is expected to run from 5th January to 22nd February, will cause GDP to decline by around 3.0% m/m in January and by around 3.5% q/q in Q1 as a whole. Previously we thought GDP would rise by around 1.0% q/q in Q1. As we estimate that GDP fell in Q4 of last year too (by around 3.0% q/q), a fall in Q1 would satisfy the usual definition of a recession of two consecutive quarters of falling output. That would be the second recession since the crisis started.
  • At first sight, our forecast of a 3.0% m/m decline in January makes this third lockdown look less harsh than the second lockdown in November (which we expect reduced GDP by 8.0% m/m) and much less severe than first lockdown in March/April (which reduced GDP by a cumulative 24.7%). But the relative monthly changes in GDP can provide a misleading signal. It’s more informative to look at the level of GDP.
  • The economic consequences of this third lockdown will certainly be smaller than the first when GDP fell to 24.7% below its level in February 2020. That’s because this time the manufacturing and construction sectors will stay open and many employees in the services sector are more able to work from home. But the fallout will be a bit bigger than the second lockdown in November. Manufacturing and construction were open then too, but this time the schools are closed. That on its own may directly reduce GDP by around 1.2 ppts in January. So while we think November’s lockdown left GDP about 14% below the level in February 2020, we estimate that January’s lockdown will take it to about 15% below. (See Chart 1.)
  • Our forecasts assume that schools reopen once the lockdown ends in late-February, but that GDP won’t rise much in March and April as most areas are put under tier 3 or tier 4 restrictions. Assuming the government manages to vaccinate the most vulnerable in the coming months, those restrictions may be eased more significantly in May and June, thereby allowing a rapid rebound in GDP. (See Chart 1 again.)
  • That rebound happens later than we previously expected, so the economy is unlikely to return to its pre-crisis peak in Q1 2022 as we previously thought. But our forecast that it will get there in Q2 2022 is more optimistic than most. Our view is partly based on the lessons from history that suggest once pandemics pass, people are quick to return to their previous behaviours. (See here.)
  • What’s more, while this third lockdown may prove to be the straw that broke the camel’s back for some businesses, we still think the economy will escape from this crisis without much long-term scarring. (See here.) As such, by the middle of the decade, GDP may be pretty much where it would have been if COVID-19 never existed. (See Chart 2.)
  • The increase in the government’s support for businesses announced this morning is small by recent standards as it amounts to only £4.6bn or 0.2% of 2019 GDP. But that money, in the form the grants worth up to £9,000 per property for affected firms and the £1.1bn given to local authorities to distribute, may help keep some businesses afloat. It certainly looks as though the Budget on 3rd March will concentrate on supporting the economy rather than laying out a plan to rein in the ballooning budget deficit. (See here.)
  • The third lockdown may prompt the Bank of England to loosen monetary policy further at its next policy meeting on 4th February. The markets have priced in a greater chance of the Bank cutting interest rates from +0.1% now to below zero within the next two years, which has contributed to the decline in 2-year gilt yields from -0.05% in late December to -0.15% and the fall in 10-year yields from +0.30% to +0.19%. But the Bank has yet to make much headway into the £150bn of extra quantitative easing it announced in November, so looser policy is already in the pipeline. And its systems are not yet set up to cope with negative interest rates. We’re not convinced the Bank will do more. As such, gilt yields may rebound.
  • Overall, the lockdown increases our belief that 2021 will be a year of two halves. The first will be characterised by restrictions and economic restraint. But, as long as the vaccines are rolled out fairly quickly and provide protection against the various variants of the virus, then the theme for the second half of the year will be one of a release of restrictions and of rapid economic recovery.

Chart 1: UK Real Monthly GDP (February 2020 = 100)

Chart 2: UK Real Quarterly GDP (Q4 2019 = 100)

Sources: Refinitiv, Capital Economics

Sources: Refinitiv, Capital Economics

Paul Dales, Chief UK Economist, +44 (0)7939 609 818,