Extra fiscal support to cushion the blow, but not eliminate it - Capital Economics
UK Economics

Extra fiscal support to cushion the blow, but not eliminate it

UK Economics Update
Written by Ruth Gregory

The policy measures announced today by the Chancellor will go some way to cushioning the blow to the economic recovery from the new restrictions to contain COVID-19 and limiting the long-term hit to unemployment. But these actions won’t eliminate the hit entirely. That is why we think GDP will stagnate in the last three months of the year and take until end-2022 to return to its pre-crisis level.

  • The policy measures announced today by the Chancellor will go some way to cushioning the blow to the economic recovery from the new restrictions to contain COVID-19 and limiting the long-term hit to unemployment. But these actions won’t eliminate the hit entirely. That is why we think GDP will stagnate in the last three months of the year and take until end-2022 to return to its pre-crisis level.
  • In response to the government’s new restrictions to contain COVID-19, that will weigh on GDP and employment, the centrepiece of Rishi Sunak’s Winter Economic Plan (which replaces the November Budget) is the six-month long “Job Support Scheme” starting on 1st November, perhaps costing about £3bn. This replaces the furlough scheme due to end on 31st October. On top of this, the Chancellor announced an extension of the VAT cut for hospitality/tourism from 20% to 5% from 13th January to 31st March (costing about £1.5bn) and he announced that firms will be given the flexibility to spread deferred VAT payments, which were due in March 2021, over 11 smaller repayments. What’s more, the government’s four loan schemes will be extended to the end of November and the terms of the Bounce Back and Coronavirus Business Interruption Loans will be increased from 6 to 10 years.
  • All in, the new measures could cost about £5bn (0.2% of 2019 GDP). This means that the total cost of the government’s COVID-19 support could be in the region of £200bn (8.9% of GDP). Once you add in the adverse effects on the public finances from the weak economy, the result could be that the Chancellor ends up borrowing a whopping £370bn (18.4% of GDP) in 2020/21. That could push up the debt to GDP ratio from 88.4% in 2019/20 to 102% in 2020/21 as a whole.
  • At the very least, this extra fiscal support should help to temper the rise in unemployment at the end of the furlough scheme in October, prevent further corporate insolvencies and boost activity in the hospitality sector at the start of 2021. Even so, the “Job Support Scheme” provides less generous support for the economy than the furlough scheme did. The government was paying 60% of salaries under the furlough scheme and companies were paying 20%. Under the new scheme, the company pays a minimum of 55% and the government pays a maximum of 22%. (See Charts 1 & 2.) And instead of receiving these payments for not working at all, employees now have to work at least a third of their normal hours. Admittedly, it makes sense that the “Job Support Scheme” is not as supportive as the furlough scheme as the government’s new restrictions are not as tight as those in March.
  • But we suspect the effect of the government’s restrictions announced this week and the possibility of tighter restrictions in the coming months will outweigh any downward impact on unemployment from today’s fiscal package. (See here.) That’s why we expect the unemployment rate to rise further, to at least 7% by the middle of next year.
  • Overall, the Chancellor is playing his part in supporting the recovery. And it may soon be the Bank of England’s turn to show that it is doing all it can to prevent the recovery from going into reverse in the coming months. We don’t think the Bank will use negative interest rates in the next 6-12 months. But we expect it to announce a £100bn expansion of QE by November and an extra £150bn next year.

Chart 1: Contributions to Employee Wages (%)

Chart 2: Contributions to Employee Wages (%)

Source: Capital Economics

Source: Capital Economics


Ruth Gregory, Senior UK Economist, +44 7747 466 451, ruth.gregory@capitaleconomics.com