COVID-19 economic hole far smaller - Capital Economics
UK Economics

COVID-19 economic hole far smaller

UK Economics Weekly
Written by Ruth Gregory

November’s GDP figures which suggested that the economy ended 2020 in a far better position than we had thought and the promising start to the vaccine roll out have given us some cause for optimism. We were already more upbeat than most forecasters in expecting GDP to return to its pre-virus level in Q2 2022. We now think Q1 2022, if not late this year, is plausible.

This week’s news on the economic damage caused by the virus and the efforts to fight it have given us some cause for optimism. By 13th January, 4.4% of the population had received their first COVID-19 vaccination dose. Admittedly, in order to achieve its target of about 14 million vaccinations by 15th February, the government needs to raise daily vaccinations from 280,000 now to 340,000. That seems ambitious, but it has ramped up daily inoculations by about 67,000 recently. (See Chart 1.) And despite rising hospitalisations and fatalities, at least new COVID-19 cases are coming down.

Chart 1: Number of People Vaccinated (Millions)

Source: UK Government

Of course, there isn’t a mechanical link between the rates of infection and restrictions on the economy. Much depends on the Secretary of State for Health, Matt Hancock’s, four conditions for lifting the lockdown. First, that there isn’t another major, new variant of the virus causing difficulties. Second, that the vaccination programme is working. Third, the number of hospitalisations is coming down. Fourth, the number of deaths is coming down.

Admittedly, even once these four conditions are met, Boris Johnson has said there will be a “gradual unwrapping” of restrictions rather than a “big bang”. So the economy entered the third lockdown with regional restrictions in place and it will probably exit it with regional restrictions in place. That would be very different to the national opening of the economy from May 2020. That’s why in our latest set of economic forecasts, we have assumed that schools reopen once the lockdown ends in late-February, but that GDP won’t rise much in March and April as most areas remain under tier 3 or tier 4 restrictions. But if the promising start to the vaccine rollout is maintained, a big easing in restrictions after June should allow GDP to rebound rapidly in Q3.

And November’s GDP figures, which showed that the economy shrank by 2.6% m/m during the second lockdown rather than the 5% m/m or more most were expecting, suggests that the economy ended 2020 in a far better position than we had thought. That means the level of GDP may now be close to 10% below its pre-crisis peak rather than 15%, roughly a GFC-recession smaller! (See here.) We were already more optimistic than most forecasters in expecting GDP to return to its pre-virus level in Q2 2022. We now think Q1 2022, if not late this year, is plausible. We will publish full forecasts in our Economic Outlook next week.

Divisions on the MPC

This supports our view that the Bank of England won’t need to resort to negative interest rates (NIR). Indeed, the MPC itself is unsure whether the Bank should use NIR. While MPC member Silvana Tenreyro this week outlined her support for NIR, Governor Bailey pointed out “there are a lot of issues with it”. Whether these disagreements result in a majority of MPC members voting for NIR depends on two key things. First, that financial institutions are operationally ready to deal with NIR. Second, that the MPC judges more stimulus is required. With the Bank yet to report on its consultation about firms’ readiness for NIR and £150bn of QE in the pipeline, we doubt either condition will be met. (See here.)

The week ahead

We think that public borrowing surged in December and the rebound in retail sales was cut short by the introduction of tier 4 restrictions (data due on Friday). January’s PMIs (also due Friday) may point to a reasonably mild fall in GDP at the start of the year, as was the case during November’s lockdown.


Data Previews

Consumer Prices (Dec.) Wed. 20th Jan.

Forecasts

Time (GMT)

Previous

Consensus

Capital Economics

Consumer Prices m/m(y/y)

07.00

-0.1%(+0.3%)

+0.2%(+0.5%)

+0.1%(+0.4%)

Core Consumer Prices m/m(y/y)

07.00

-0.1%(+1.1%)

+0.1%(+1.3%)

+0.1%(+1.2%)

Lockdown keeps inflation low

We suspect that CPI inflation will tick up a little after November’s sharp drop, before starting to rise from April to reach 2.5% by the end of the year. But some of that increase will probably be short-lived.

The big drops in food and clothes prices, which dragged CPI inflation down to just 0.3% in November, probably weren’t repeated in December. But the placing of most of the country into tier 4 COVID-19 restrictions in the second half of December meant that prices of most goods and services won’t have risen much.

The one area of strength could have been transport, where air fares inflation may have jumped from an artificial 0.2% in November (the ONS could not get any actual prices in November so it estimated airfares inflation) to 5% in December. However, even this would only be enough to drag CPI up to 0.4% and push up core CPI from 1.1% to 1.2%.

The big picture, though, is that higher commodity prices and tax rises will probably push inflation to around 2.5% by early 2022, before it falls back to 1.5% by the end of 2022. (See Chart 2.)

Chart 2: CPI Inflation (%)

Sources: Refinitiv, Capital Economics

Public Finances (Dec.) Fri. 22nd Jan.

Forecasts

Time (GMT)

Previous

Consensus

Capital Economics

PSNB ex. Banking Groups

07.00

£31.6bn

+£32.0bn

£35.0bn

Public Sector Net Cash Requirement

07.00

£23.9bn

£32.0bn

Borrowing still soaring

Borrowing probably rose again in December as most of the country was placed under tier 4 COVID-19 restrictions and government spending on public services ramped up.

The government may have borrowed even more in December than it did in November. Admittedly, tax receipts probably rose a little from £53.9bn in November to £56bn as some people returned to work and retail sales ticked up. But spending on social benefits and public services probably rose sharply as the government prepared for the rollout of the vaccine and increased support for businesses forced to close. Total government expenditure may have risen from £80.6bn to about £91.0bn.

That may mean the government borrowed £35.0bn, with a corresponding cash (PSNCR) deficit of about £32.0bn.

Borrowing is likely to remain high for the next few months as January’s third COVID-19 lockdown keeps many businesses closed. Overall, we expect the deficit to reach £420bn (21.7% of GDP) in 2020/21, well above the OBR’s November projection of £394bn. (See Chart 3.)

Chart 3: Year-to-Date PSNB ex. (£bn)

Sources: Refinitiv, OBR, Capital Economics

Retail Sales (Dec.) Fri. 22nd Jan.

Forecasts

Time (GMT)

Previous

Consensus

Capital Economics

Retail Sales Volumes (Including Petrol)

07.00

-3.8%(+2.4%)

+1.0%(+4.0%)

+0.5%(+3.5%)

A month of two halves

December’s rebound in retail sales was probably cut short by the closure of many shops before Christmas. But strong food and drink sales might have ensured that the month wasn’t a complete write-off for retailers.

Preliminary data from supermarkets and department stores suggest that food sales continued to be strong in December after rising by 3.1% m/m in November. This isn’t surprising given that the hospitality sector remained closed during Christmas and New Year. Spending in non-essential shops also probably rebounded in the first half of December as COVID-19 restrictions were lifted. But the introduction of tier 4 on 20th December may have stumped the recovery. Indeed, the BRC Survey for December rose slightly to +1.8% y/y in December, which would imply sales rose by about 0.5% m/m. (See Chart 4.) Looking ahead, we expect retail sales to remain fairly soft until restrictions are lifted, stores reopen and consumers spend their forced savings.

Chart 4: BRC Implied Real Sales

Sources: Refinitiv, BRC

IHS Markit/CIPS Flash PMIs (Jan.) Fri. 22nd Jan.

Forecasts

Time (GMT)

Previous

Consensus

Capital Economics

Flash Composite PMI

09.30

50.4

40.0

47.0

Flash Manufacturing PMI

09.30

57.5

53.0

56.5

Flash Services PMI

09.30

49.4

45.0

46.0

PMIs probably understate the hit to activity in January

January’s PMIs are almost certain to have fallen as the economy was once again clobbered by the lockdown starting on 5th January. If anything, things may prove worse than the PMIs suggest.

At least the manufacturing PMI may not have fallen by much. Factories were exempt from January’s lockdown, so the output balance probably stayed close to December’s 55.3. The stocks of purchases balance probably fell in January, as was the case after the last Brexit deadline in March. But supply chain disruption due to Brexit and the COVID-19 border closures probably lengthened suppliers’ delivery times. Longer delivery times are usually associated with strong demand, so this would provide a small boost to the headline index. We have pencilled in a small fall in the manufacturing PMI from 57.5 to 56.5. By contrast, the services PMI may have declined from 49.4 to around 46.0. That would drag down the composite index from 50.4 to 47.0 and would be consistent with GDP contracting by 2% m/m in January. (See Chart 5.)

Chart 5: IHS Markit/CIPS Flash Composite PMI & GDP

Sources: IHS Markit, Capital Economics


Economic Diary & Forecasts

Upcoming Events & Data Releases

Date

Country

Release/Indicator/Event

Time (GMT)

Previous*

Consensus*

CE Forecasts*

Data Response

Mon 18th

UK

Rightmove House Prices (Jan)

(08.30)

-0.6%(+6.6%)

Tue 19th

UK

Unit Labour Costs (Q3)

(09.30)

+8.5%(+12.9%)

UK

Output per Hour (Q3, Final, q/q(y/y))

(09.30)

-2.4%(+3.0%)

Wed 20th

UK

CPI (Dec)

(07.00)

-0.1%(+0.3%)

+0.2%(+0.5%)

+0.1%(+0.4%)

DR

UK

Core CPI (Dec)

(07.00)

-0.1%(+1.1%)

+0.1%(+1.3%)

+0.1%(+1.2%)

DR

UK

CPIH (Dec)

(07.00)

-0.1%(+0.6%)

+0.1%(+0.7%)

DR

UK

RPI (Dec)

(07.00)

-0.3%(+0.9%)

+0.5%(+1.1%)

+0.7%(+1.3%)

DR

UK

PPI Output (Dec, nsa)

(07.00)

+0.2%(-0.8%)

+0.1%(-0.7%)

+0.1%(-0.7%)

DR

UK

PPI Input (Dec, nsa)

(07.00)

+0.2%(-0.5%)

DR

Thu 21st

No Significant Data Released

Fri 22nd

UK

GfK Consumer Confidence (Jan)

(00.01)

-26

-30

-25

UK

PSNB ex Banking Groups (Dec)

(07.00)

+£31.6bn

+£32.0bn

+£35.0bn

DR

UK

Central Gov. Net Cash Requirement (Dec)

(07.00)

+£23.9bn

+£32.0bn

DR

UK

Retail Sales Inc. Fuel (Dec)

(07.00)

-3.8%(+2.4%)

+1.0%(+4.0%)

+0.5%(+3.5%)

DR

UK

IHS Markit/CIPS Composite PMI (Jan, Flash)

(09.30)

50.4

40.0

47.0

DR

UK

IHS Markit/CIPS Manufacturing PMI (Jan, Flash)

(09.30)

57.5

53.0

56.5

DR

UK

IHS Markit/CIPS Services PMI (Jan, Flash)

(09.30)

49.4

45.0

46.0

DR

Also expected during this period:

18th – 24th

UK

CBI Industrial Trends Survey (Jan/Q1)

(11.00)

-25

-35

Selected future data releases and events

Tue 26th

UK

Labour Market (Dec/Nov)

(07.00)

DR

28th – 3rd

UK

Nationwide House Prices (Jan)

(07.00)

+0.8%(+7.3%)

*m/m(y/y) unless otherwise stated

Sources: Bloomberg, Capital Economics

Main Economic & Market Forecasts*

%q/q(%y/y) unless stated

Latest

Q3 2020

Q4 2020

Q1 2021

Q2 2021

Q3 2021

Q4 2021

2020

2021

2022

GDP

+16.0(-8.6) Q3

+16.0(-8.6)

+0.6(-8.1)

-1.5(-6.7)

+3.0(+18.3)

+4.0(+6.0)

+1.5(+7.0)

(-10.0)

(+5.5)

(+6.5)

CPI inflation

(+0.3) (Nov)

(+0.6)

(+0.5)

(+0.1)

(+1.3)

(+1.5)

(+2.0)

(+0.8)

(+1.2)

(+1.7)

ILO unemployment rate (%)

4.9 (Oct)

4.8

5.2

5.5

5.9

6.2

6.4

4.5

6.0

5.5

Bank Rate, end period (%)

0.10

0.10

0.10

0.10

0.10

0.10

0.10

0.10

0.10

0.10

10 yr gilt, end period (%)

0.31

0.25

0.24

0.30

0.35

0.40

0.50

0.24

0.50

0.50

$/£, end period

1.36

1.29

1.35

1.37

1.38

1.39

1.40

1.35

1.40

1.45

Euro/£, end period

1.12

1.14

1.13

1.12

1.12

1.12

1.12

1.13

1.12

1.12

Sources: Capital Economics, Refinitiv

* Assumes that severe COVID-19 restrictions are in place during January and February and that restrictions are eased very gradually in March, April, May and June. (See here.)


Ruth Gregory, Senior UK Economist, +44 (0)7747 466 451, ruth.gregory@capitaleconomics.com