Unemployment set to rise further, but not as far as feared - Capital Economics
UK Economics

Unemployment set to rise further, but not as far as feared

UK Economics Update
Written by Ruth Gregory

Given the success of the government’s job furlough scheme and the signs of a strong initial rebound in economic activity we now think that the unemployment rate will peak later, in June 2021 rather than in July 2020, and at a lower rate of 7%, previously 8.5%. Even so, we still think that it will be many years before the unemployment rate returns to pre-pandemic level of 4%.

 

  • Given the success of the government’s job furlough scheme and the signs of a strong initial rebound in economic activity we now think that the unemployment rate will peak later, in June 2021 rather than in July 2020, and at a lower rate of 7%, previously 8.5%. Even so, we still think that it will be many years before the unemployment rate returns to pre-pandemic level of 4%.
  • We think that we have done a fairly good job of forecasting the economy recently, correctly predicting the 25% peak-to-trough fall in economic activity. But if there is one thing that we, and most forecasters, have got wrong, it is the outlook for the labour market. We had forecast that the level of unemployment would rise by 1.6 million and that the ILO unemployment rate would reach a little above 8.5% by July. (See here.) But so far unemployment has only risen modestly by 34,000 in April.
  • Admittedly, an exodus from the labour force flattered April’s figures. While employment fell by 429,000 between March and April, there was a 425,000 jump in “inactivity” (this is defined as those who have not actively sought work in the past four weeks and/or are not available to start work in the next two weeks). (See here.) What’s more, the labour market tends to respond to changes in the wider economy with a time lag. Timelier HMRC data suggest that another 171,000 people lost their jobs in May. And the number of people claiming work-related benefits in May surged by 1.6m, from 1.2m to 2.8m since March – although given the increase in the generosity of benefits in March, this is likely to overstate the rise in unemployment. (See here.) Nevertheless, our previous unemployment forecasts now look overly pessimistic.
  • Two factors explain the improved labour market outlook. First, the recent data suggest that the rebound in economic activity has occurred sooner and has been a bit stronger than we had previously anticipated. We now think that GDP might contract by 15%-20% in Q2 compared with the 23% we previously forecast. (See here.)
  • Second, and more importantly, the take-up and duration of the government’s job furlough scheme has far exceeded expectations. The scheme has acted like a bridge, limiting the fall in employment, pushing out the peak and flattening the curve in unemployment. (See Charts 1 & 2.) Indeed, the scheme has already been extended by four months, from the end of June to the end of October. And the government is now paying 80% of the salaries (up to £2,500) a month of 9.3 million employees. Adding in the extra 2.6 million people receiving grants on the Self Employment Income Support Scheme (worth 80% of average monthly trading profits of up to £7,500 in total for three months), the government is providing the livelihood of almost 12 million workers (35% of the workforce).
  • We still think that unemployment will rise further this year, as the government increasingly shifts the cost of the furlough scheme onto employers. From 1st August, businesses will be required to pay National Insurance and pension contributions for their furloughed workers. From 1st September, they will be required to pay 10% of their salaries. And from 1st October, 20% of their salaries, before the scheme ends entirely on 31st October.

Chart 1: GDP & Employment

Chart 2: ILO Unemployment Rate (%)

Sources: Refinitiv, Capital Economics

Sources: Refinitiv, Capital Economics

  • But how far unemployment rises and when, depends on four key uncertainties. First, whether the government keeps the furlough scheme going, either in its current form or for certain sectors, rather than winding it down. Second, whether firms use the furlough scheme for as long as they can, or if they lay off their furloughed workers as soon as they are required to contribute to their costs. Third, of those furloughed workers who are not recalled to their jobs, how many are added to the pool of unemployed and how many leave the labour market (i.e. become “inactive”). Fourth, whether those leaving the labour market do so permanently, or as businesses re-open, start searching for a job.
  • For the time being, we assume that the government will stick to its current plans to taper the furlough scheme but that help for employees moving to short-time working and tax breaks for employers may be on the way in the Chancellor’s fiscal statement due on July 8th. (See here.)
  • We have taken a neutral assumption that an equal proportion of workers (around 2.2m) are taken off the furlough scheme each month from August to November. Of those furloughed workers who lose their jobs – we assume about 15% or 330,000 initially in August – roughly equal proportions flow into unemployment and inactivity.
  • Further down the line, we assume that those would-be workers who leave the labour force in the aftermath of the crisis due to the lack of available jobs are gradually tempted back by stronger job prospects. That is why the unemployment rate continues to rise well after the job furlough scheme ends on 31st October, as the number of inactive people becoming unemployed more than offsets the number of unemployed people moving into employment.
  • Based on this, we expect unemployment to rise by around 1m from 1.34m to 2.36m by June 2021, taking the unemployment rate from 3.9% in April to a peak of around 7%. That is a smaller and more gradual rise than the increase in the unemployment rate to 8.5% by July 2020 that we had previously expected. (See Chart 2 again.) Even so, this does not change the overall picture that with the unemployment rate likely to remain above its pre-pandemic rate of around 4% until 2023, the labour market will remain a constraint on the pace of the economic recovery for some time yet.

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