Policymakers start to withdraw support - Capital Economics
UK Economics

Policymakers start to withdraw support

UK Economics Weekly
Written by Andrew Wishart

August marks the beginning of the phasing out of the extraordinary policy support that has seen the economy through the coronavirus crisis so far. The winding down of the furlough scheme while economic activity is still well below pre-virus levels will inevitably result in the small fall in employment so far turning into a much bigger one . And the resurgence of the virus in Spain and parts of the North of England highlights the risk that more severe and widespread outbreaks and restrictions cause the recovery to stall or, in the worst-case scenario, the economy to endure a double-dip recession.

Easing the economy off life support

As we enter August, we come to the first of many crunch points in the economy’s recovery from the coronavirus. (See here.) The labour market has been in suspended animation with the government’s furlough scheme covering the full cost of furloughed employees, keeping unemployment low. But from tomorrow (1st August) it starts to be wound down.

The good news is that perhaps a third of the 9.5 million jobs furloughed are no longer on the scheme. As there is not yet any cost to companies for furloughing workers, presumably the bulk of these have returned to work. But most are still on the scheme, accounting for about 19% of the total workforce. From 1st August firms will have to pay the national insurance and pension contributions of furloughed workers, and from 1st September 10% of their wage too, rising to 20% from 1st October. So from 1st August a bigger share may go from furlough to unemployment instead of back to work.

Meanwhile, economic activity is still well below pre-crisis levels. It is difficult to judge the extent of the recovery from the 26% drop in GDP between February and April, but our new CE BICS indicator makes a good fist of it. It suggests that GDP was still about 15% below pre-virus levels in the first half of July. (See here.) The recovery will have made further progress over the past fortnight, but the reduction in GDP compared to its pre-virus level is still huge and almost certainly still larger than the 7% peak-to-trough fall in the Global Financial Crisis.

The winding down of the furlough scheme while activity is still depressed will surely cause the quite small fall in employment so far to turn into a much bigger one. Our forecast is that employment will fall by about 5% and that the unemployment rate will rise from 3.8% to a peak of 7.0% in mid-2021.

Indeed, households are increasingly downbeat about their job prospects. In July, the unemployment expectations balance of the European Commission’s confidence survey – a good predictor of changes in the unemployment rate – surged. It is consistent with the unemployment rate having risen from 3.9% in May to about 5.0% in July. (See Chart 1.)

Chart 1: Household Unemployment Expectations & Changes in the Unemployment Rate

Sources: Refinitiv, EC, Capital Economics

Second wave the major risk

A big rise in unemployment is already baked into our forecast, but a significant surge in new virus cases is not. Our forecast is based on there being some localised outbreaks and lockdowns. But the resurgence of the virus in Spain and now northern England highlights the risk that they are more severe and widespread than we have assumed. In that scenario the economy could endure a double-dip recession. (See here.)

However, increasing concern that this risk will crystallise probably won’t prompt the Bank of England to announce further stimulus at its next meeting on 6th August. (See here.) The further £100bn of QE unveiled in June will keep asset purchases ticking over until the end of the year. But the Bank’s latest forecast could show that the MPC thinks the economy will take longer to recover than it did in May. That would send a signal that more policy action will eventually be needed, perhaps including negative interest rates.

The week ahead

Aside from the MPC meeting on Thursday, the final PMIs will be published between Monday and Thursday and should confirm that the recovery continued in July.


Economic Diary & Forecasts

Upcoming Events & Data Releases

Date

Country

Release/Indicator/Event

Time (BST)

Previous*

Consensus*

CE Forecasts*

UK Data Response

Mon 3rd

UK

IHS Markit/CIPS Manufacturing PMI (Jul, Final)

(09.30)

53.6p

53.6

53.6

Tue 4th

No Significant Data Released

Wed 5th

UK

New Car Registrations (Jul)

(09.00)

(-34.9%)

UK

IHS Markit/CIPS Services PMI (Jul, Final)

(09.30)

56.6p

56.6

56.6

UK

IHS Markit/CIPS Composite PMI (Jul, Final)

(09.30)

57.1p

57.1

57.1

Thu 6th

UK

BoE Monetary Policy Decision (Aug)

(07.00)

+0.10%

+0.10%

+0.10%

DR

UK

BoE Asset Purchase Target (Aug)

(07.00)

£745bn

£745bn

£745bn

DR

UK

BoE Rate Votes (Aug, hike-unchanged-cut)

(07.00)

(0-9-0)

(0-9-0)

(0-9-0)

DR

UK

BoE QE Votes (Aug, reduce-unchanged-increase)

(07.00)

(0-1-8)

(0-9-0)

DR

UK

BoE Monetary Policy Report (Aug)

(07.00)

DR

UK

BoE Financial Stability Report (Aug)

(07.00)

UK

IHS Markit/CIPS Construction PMI (Jul)

(09.30)

55.3

57.0

57.0

DR

UK

IHS Markit/CIPS All-Sector PMI (Jul)

(09.30)

48.3

57.0

DR

Fri 7th

UK

Halifax House Prices (Jul)

(08.30)

-0.1%(+2.5%)

Selected future data releases and events

Tue 11th

UK

Labour Market (Jun/Jul)

(07.00)

DR

Wed 12th

UK

GDP (Q2, q/q(y/y))

(07.00)

-2.2%(-1.8%)

DR

UK

GDP (Jun, m/m(3m/3m))

(07.00)

+1.8%(-19.1%)

DR

UK

Service Output (Jun)

(07.00)

+0.9(-23.6%)

DR

UK

Industrial Production (Jun)

(07.00)

+6.0%(-20.1%)

DR

UK

Construction Output (Jun)

(07.00)

+8.2%(-39.7%)

DR

UK

Trade Balance (Jun)

(07.00)

+£4.3bn

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

2022

GDP

-2.2(-1.7) (Q1)

-2.2(-1.7)

-21.5(-22.8)

+14.2(-12.3)

+5.2(-7.7)

(+1.5)

(-11.0)

(+9.5)

(+3.3)

CPI inflation

(+0.6) (Jun.)

(+1.7)

(+0.6)

(-0.1)

(+0.2)

(+1.8)

(+0.6)

(+1.2)

(+1.3)

ILO unemployment rate (%)

3.9 (May)

3.9

4.1

5.5

6.4

3.8

5.0

6.7

5.5

Bank rate, end period (%)

+0.10

+0.10

+0.10

+0.10

+0.10

+0.75

+0.10

+0.10

+0.10

10 yr gilt, end period (%)

0.08

0.36

0.17

0.17

0.25

0.83

0.25

0.25

0.25

$/£, end period

1.31

1.24

1.25

1.30

1.35

1.33

1.35

1.35

1.35

Euro/£, end period

1.11

1.14

1.11

1.12

1.13

1.18

1.13

1.13

1.13

Sources: Capital Economics, Refinitiv

* Assumes the UK and the EU agree a slim trade in goods deal by the end of the year, with the status quo for services and financial services maintained until a later date. (See here.)


Andrew Wishart, UK Economist, +44 7427 682 411, andrew.wishart@capitaleconomics.com