Policymakers do their utmost, but some damage already done - Capital Economics
UK Economics

Policymakers do their utmost, but some damage already done

UK Economics Weekly
Written by Ruth Gregory

The UK Chancellor’s support for self-employed workers takes the total size of the government’s package of direct tax and spending measures to £119bn (5.3% of GDP). Even so, this unparalleled policy response won’t prevent a precipitous drop in economic activity in Q2. And the big risk now is that many more people are made unemployed, many more businesses fail, and firms and households become more reluctant to spend even once the virus is under control. That could mean that the recovery is slower and more protracted than we are currently expecting.

While we still expect the economy to rebound strongly after the virus has been contained, the surge in Universal Credit benefit claims this week raises the risk that it won’t get back to “normal” as quickly as we had previously thought.

Policymakers throw the kitchen sink

The UK government has now put in place an unprecedented package of direct tax and spending measures that we estimate is worth £119bn (5.3% of GDP). Chancellor Rishi Sunak’s announcement yesterday was the latest instalment – his fourth in just over two weeks (see here) – in which he pledged another £9bn (0.4% of GDP) of support for self-employed workers. (See here.)

Admittedly, the Bank of England took a break this week and left policy unchanged. (See here.) But it has already gone a long way very quickly, having cut interest rates to 0.10%, pledged to buy £200bn of assets and established new facilities to provide cheap funding to banks and loans directly to businesses. (See here.) The current fiscal stimulus is at two-and-a-half times the size of that seen in the financial crisis. And while the Bank’s asset purchases, worth 9% of GDP, are lower than the 12.8% seen after the financial crisis, this time they will happen quicker. (See Chart 1.)

Chart 1: Fiscal Stimulus & QE (% of GDP)

Sources: HMT, BoE, Capital Economics

The consequence is that the budget deficit will blow out from around 2% of GDP to almost 11% of GDP, government debt will jump from 77% to about 105% (see here) and following its QE purchases, the Bank of England’s balance sheet will rise from 20% of GDP to 29%. These levels are far above those seen after the financial crisis.

What policy can’t do

But while the unprecedented levels of policy support might help the economy to rebound later in the year, they won’t prevent economic activity from falling off a cliff in Q1 and Q2. March’s activity PMIs confirmed that the virus was having a huge negative impact even before the UK entered into a full lockdown on 23rd March. (See here.) We have pencilled in a 15% q/q fall in GDP in Q2. (See here.) But with the construction, manufacturing and real estate sectors now shutting down, a fall of 20-40% is not out of the question.

And we are getting more concerned that when it comes to unemployment, the horse may have already bolted. Even before the lockdown, in the 9 days to 16th March the number of applications for the Universal Credit scheme (which provides unemployment benefits) shot up from a normal rate of 50,000 a week to 477,000. (See here.) So it appears that many people have already lost their jobs or expect to. As such, it’s become more likely that the increase in the unemployment rate could surpass the rise from 4.0% to 6.0% we are forecasting. (See here.)

What policy can do

The policy stimulus will crucially support a faster eventual rebound in activity. But if many more people are made unemployed, many more businesses fail, and firms and households fear something similar might happen again and become more reluctant to spend, the big risk now is that the eventual recovery is slower and more protracted than we are forecasting. (See here.)

The week ahead

Next week’s data releases are not likely to tell us much more about the post-coronavirus world. We will continue to focus on the financial markets and any further policy response.


Economic Diary & Forecasts

Upcoming Events & Data Releases

Date

Country

Release/Indicator/Event

Time (GMT)

Previous*

Consensus*

CE Forecasts*

UK Data Response

Mon 30th

UK

M4 Money Supply (Feb)

(09.30)

+0.6%(+4.7%)

UK

Net Consumer Credit (Feb)

(09.30)

+£1.2bn

+£1.1bn

+£1.0bn

UK

Mortgage Approvals (Feb)

(09.30)

70,900

68,200

73,000

UK

UK Economic Sentiment (Mar)

(10.00)

95.5

85.0

DR

Tue 31st

UK

GfK Consumer Confidence (Mar)

(00.01)

-7

-14

-25

DR

UK

GDP (Q4, Final)

(07.00)

0.0%(+1.1%)

0.0%(+1.1%)

0.0%(+1.1%)

DR

UK

Current Account (Q4, Final)

(07.00)

-£15.9bn

-£7.0bn

-£7.5bn

DR

Wed 1st

UK

BRC Shop Price Index (Mar)

(00.01)

(-0.6%)

UK

IHS Markit/CIPS Manufacturing PMI (Mar, Final)

(09.30)

48.0

47.3

46.5

Thu 2nd

No Significant Data Released

Fri 3rd

UK

IHS Markit/CIPS Composite PMI (Mar, Final)

(09.30)

37.1

36.9

36.0

DR

UK

IHS Markit/CIPS Services PMI (Mar, Final)

(09.30)

35.7

35.3

34.0

DR

Also expected during this period

30th – 2nd

UK

Nationwide House Prices (Mar)

+0.3%(+2.3%)

0.0%(+2.1%)

+0.1%(+2.0%)

Selected future data releases and events

Mon 6th

UK

IHS Markit/CIPS All-Sector PMI (Mar, Final)

(09.30)

53.0

UK

IHS Markit/CIPS Construction PMI (Mar, Final)

(09.30)

52.6

Thu 9th

UK

GDP (Feb, m/m(3m/3m))

(09.30)

0.0%(0.0%)

DR

UK

Industrial Production (Feb)

(09.30)

-0.1%(-2.9%)

DR

UK

Construction Output (Feb)

(09.30)

-0.8%(+1.6%)

DR

UK

Trade Balance (Feb)

(09.30)

+£4.2bn

DR

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

Sources: Bloomberg, Capital Economics

Main Economic & Market Forecasts**

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

Latest

Q1 2020

Q2 2020

Q3 2020

Q4 2020

2019

2020

2021

GDP

0.0(+1.1) (Q4)

+0.0(+0.4)

-15.0(-14.6)

+5.0(-10.7)

+8.5(-3.2)

(+1.4)

(-7.0)

(+8.5)

CPI inflation

(+1.7) (Feb)

+0.3(+1.7)

+0.1(+0.9)

+0.2(+0.7)

+0.2(+0.8)

(+1.8)

(+1.0)

(+1.0)

ILO unemployment rate (%)

3.9 (Jan)

3.6

6.0

5.2

5.1

3.8

5.0

4.7

Bank rate, end period (%)

0.10

0.10

0.10

0.10

0.10

0.75

0.10

0.50

10 yr gilt, end period (%)

0.39

0.39

0.25

0.25

0.25

0.82

0.25

0.25

$/£, end period

1.22

1.22

1.24

1.25

1.25

1.33

1.25

1.30

Euro/£, end period

1.11

1.11

1.13

1.13

1.14

1.18

1.14

1.24

Sources: Capital Economics, Refinitiv

**Assumes the UK and the EU agree some kind of fudge that means there is not a big step change in their relationship on 31st Dec. 2020.


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