Pressure mounting on the Chancellor and BoE to do more - Capital Economics
UK Economics

Pressure mounting on the Chancellor and BoE to do more

UK Economics Weekly
Written by Ruth Gregory

With COVID-19 infections surging and the government turning to much broader and tighter restrictions, we fear that the economic recovery will soon go into reverse. That’s why we think the Chancellor will be forced to step up his support, perhaps by bolstering the Job Support Scheme so that instead of paying 66% of employee salaries the government pays 80%. We also think the Monetary Policy Committee will announce at least another £100bn of QE at its next meeting on 5th November.

 

We published our new set of economic forecasts on Monday, in which we warned that the tightening in COVID-19 restrictions would mean that GDP might not rise at all in October, November and December. We also said that the unemployment rate would rise from 4.5% in August to a peak of almost 8.0%, rather than to 7.0% as we previously thought. (See here.)

But the severity of the outbreak of the virus, which has seen the number of new confirmed COVID-19 cases reach almost 20,000 per day on Wednesday, has already prompted a tightening in measures, leaving more than 50% of England’s population subject to more restrictions. On top of that, the calls for a “circuit breaking” lockdown have grown louder. Admittedly, further restrictions might not necessarily come in the form of a nationwide lockdown, but if enough UK regions are subject to tighter measures, then it would have the same effect.

We showed in an Update how different severities and lengths of lockdowns would affect the economy. If, for example, the government opted to place the whole country under the highest restrictions for two weeks, that could knock about 2.5% off GDP in that month. (See here.)

The government has continued to insist that it is doing all that it can to provide fiscal support, but all this suggests that it will need to do much more. Most obviously, the Chancellor could bolster the Job Support Scheme so that instead of paying 66% of salaries, it pays 80%, just like it did on the nationwide furlough scheme. Admittedly, the total cost of the government’s COVID-19 support could be in the region of £220bn (10.0% 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 £390bn (19.6% of GDP) in 2020/21. That would be the highest budget deficit since WWII. But the Chancellor shouldn’t balk at spending more. After all, if he is in for a penny, he’s in for a pound. And arguably the best way to put the public finances on a more sustainable footing is to ensure the economy comes out the other side of the crisis stronger.

The Bank of England too has always stressed that its aim is to minimise the longer-term damage to the economy. So it is unlikely to rest on its laurels for long either. Admittedly, we do not think that more support will come in the form of negative interest rates. In a letter on Monday, Sam Woods, the Bank of England’s Deputy Governor for Prudential Regulation, asked UK banks about their “operational readiness” for negative rates. But on the whole, the MPC still seems concerned about the adverse impact of the policy on banks’ profitability. So we have not changed our view that over the next six months QE will remain the MPC’s tool of choice.

Even so, a rise in QE by £100bn at the meeting in November now looks like the bare minimum that should be expected. And we still expect the MPC to announce a further £150bn of QE over the following year, much more than the consensus expects. Either way, it is clear that the 10-year gilt yield, which has already sunk from 0.28% to close to our end-year forecast of 0.15%, will stay very low for a very long time.

Meanwhile, the EU said yesterday it was willing to agree a Brexit deal, but that the UK needs to compromise. Today, Boris Johnson said that the UK is willing to agree a deal, but it is the EU that needs to compromise. So the negotiations appear to be at a stalemate. Even so, it is telling that the UK has not walked away completely from the talks. We suspect there is still scope for a deal to be done, perhaps in November ahead of the European Council meeting on 10th-11th December.

The week ahead

The flash PMIs for October (due Friday) will provide a glimpse of the hit to the economy that lies ahead from the tightening in restrictions. Otherwise, we will be watching out for any hints in the plethora of MPC member speeches next week that the Bank of England is gearing up to provide more support.


Data Previews

Consumer Prices (Sep.) Wed. 21st Oct.

Forecasts

Time (BST)

Previous

Consensus

Capital Economics

Consumer Prices m/m(y/y)

07.00

-0.4%(+0.2%)

+0.4%(+0.5%)

+0.4%(+0.6%)

Core Consumer Prices m/m(y/y)

07.00

-0.6%(+0.9%)

+0.6%(+1.3%)

+0.5%(+1.2%)

Upward leg begins

We suspect that a rebound in CPI inflation to 0.6% in September will be the start of an upward leg that takes inflation close to 2% by the end of next year. But the influence of spare capacity may mean that inflation falls back to 1.5% in 2022.

The temporary VAT cut for the hospitality and tourism sectors and the government’s Eat Out to Help Out (EOHO) restaurant discount scheme drove most of the fall in CPI inflation from 1.0% in July to 0.2% in August and the decline in core inflation from 1.9% to 0.9%. Indeed, the fall in catering services inflation from +3.3% to -2.9% subtracted 0.6 ppts from overall inflation. (See Chart 1.) The effects of the VAT cut were sustained in September and some restaurants funded their own extension of the EOHO scheme. But as the EOHO scheme ended in most restaurants, we estimate that about half of the fall in catering services inflation was reversed in September. That’s the main reason why we think overall inflation rose from 0.2% to 0.6% and core inflation climbed from 0.9% to 1.2%.

Chart 1: Catering Services Inflation (%)

Source: Refinitiv

Public Finances (Sep.) Wed. 21st Oct.

Forecasts

Time (BST)

Previous

Consensus

Capital Economics

PSNB ex. Banking Groups

07.00

+£35.9bn

+£34.0bn

+£31.0bn

Central Government Net Cash Requirement

07.00

+£21.7bn

+£22.0bn

Stuttering recovery and new support will cause borrowing to rise faster

While borrowing in the first five months of the financial year eclipsed that in the whole of 2009/10 (the worst year on record in cash terms) it was lower than the OBR anticipated. But the stuttering recovery and further fiscal support will soon cause a renewed increase in the pace of borrowing.

A final £6bn Self Employment Support Scheme payment pushed up monthly borrowing to £35.9bn in August, so the government probably borrowed less in September. We’ve pencilled in around £31bn. That would leave borrowing in the year to date about five times higher than over the same period in 2019/20, but still 20% below the OBR’s July projection. (See Chart 2.)

Much of the outperformance is because the initial economic recovery was stronger than the OBR expected. But it is now petering out. Meanwhile, the government has announced new fiscal support schemes for firms having to shut down due to local lockdowns. The result is that we expect the government will have to borrow £390bn this year (19.6% of GDP), some £18bn more than the OBR’s £372bn projection.

Chart 2: Year-to-Date PSNB ex. (£bn)

Sources: Refinitiv, OBR, Capital Economics

Retail Sales (Sep.) Fri. 23rd Oct.

Forecasts

Time (BST)

Previous

Consensus

Capital Economics

Retail Sales Volumes (Including Petrol)

07.00

+0.8%(+2.8%)

+0.3%(+3.7%)

+1.5%(+4.6%)

Retail sales rise as consumers return to their kitchens

We suspect retail sales made further gains in September, benefitting from the end of the Eat Out to Help Out (EOHO) restaurant discount scheme and the mini-boom in the housing market.

After a subdued rise of just 0.8% m/m in August, retail sales growth may have picked up in September. The end of the government’s EOHO scheme is likely to have caused an increase in food sales as consumers traded meals out for home cooking. (See Chart 3.) We also expect the continued mini-boom in the housing market to have pushed up purchases of DIY and household items.

Admittedly, a significant rise in new COVID-19 infections in September meant that footfall on major UK high streets fell from -37% y/y in August to -46% in September. However, we think that consumers probably reverted to shopping online. And there have also been anecdotal reports of shoppers stockpiling goods again. The net effect may have been a 1.5% m/m rise in retail sales in September. That would leave them 4.6% above their pre-virus level.

Chart 3: Number of Restaurant Diners (7 day avg., % y/y)

Source: OpenTable

IHS Markit/CIPS Activity Flash PMIs (Oct.) Fri. 23rd Oct.

Forecasts

Time (BST)

Previous

Consensus

Capital Economics

Flash Composite PMI

09.30

56.5

53.9

53.8

Flash Manufacturing PMI

09.30

54.1

53.2

54.0

Flash Services PMI

09.30

56.1

53.8

52.5

PMIs ease off due to restrictions to counter virus

The flash PMIs for October are likely to provide evidence that the recovery is stuttering, especially in the services sector.

Strong order books combined with low levels of inventory, as manufacturing firms continue to make up for reduced output earlier in the year, is likely to mean the manufacturing PMI remained high in October. We expect that it more or less held steady, at 54.0 down from 54.1 in September.

However, the services PMI probably fell, reflecting the resurgence of the virus over the past few weeks and the associated tightening of restrictions. The 10pm curfew on pubs and bars, advice to work from home where possible, restrictions on household mixing and individuals exercising greater caution has caused visits to retail and recreation premises and journeys on public transport to fall back. (See Chart 4.) That may translate into a fall in the services PMI from 56.1 to 52.5. That would drag down the composite index from 56.5 to 53.8.

This would be broadly consistent with our forecast that GDP will flatline in October, and perhaps in November and December too. And further restrictions could yet cause GDP to fall again.

Chart 4: Google Mobility (7 day av., Jan. 2020=100)

Sources: Google, Capital Economics


Economic Diary & Forecasts

Upcoming Events & Data Releases

Date

Country

Release/Indicator/Event

Time (BST)

Previous*

Consensus*

CE Forecasts*

Data Response

Sun 18th

UK

MPC’s Bailey speaks at IBS

(14.05)

Mon 19th

UK

Rightmove House Prices (Oct)

(00.01)

+0.2%(+5.0%)

UK

MPC’s Cunliffe speaks on currencies

(15.05)

Tue 20th

UK

MPC’s Vlieghe speaks on econ. outlook

(10.30)

Wed 21st

UK

CPI (Sep)

(07.00)

-0.4%(+0.2%)

+0.4%(+0.5%)

+0.4%(+0.6%)

DR

UK

Core CPI (Sep)

(07.00)

-0.6%(+0.9%)

+0.6%(+1.3%)

+0.5%(+1.2%)

DR

UK

CPIH (Sep)

(07.00)

-0.3%(+0.5%)

+0.3%(+0.7%)

+0.4%(+0.8%)

DR

UK

RPI (Sep)

(07.00)

-0.3%(+0.5%)

+0.3%(+1.1%)

-0.1%(+0.7%)

DR

UK

PPI Input (Sep)

(07.00)

-0.4%(-5.8%)

-0.5%(-5.4%)

DR

UK

PPI Output (Sep)

(07.00)

0.0%(-0.9%)

-0.1%(-0.9%)

DR

UK

PSNB ex. Banking Groups (Sep)

(07.00)

+£35.9bn

+£34.0bn

+£31.0bn

DR

UK

Central Gov. Net Cash Requirement (Sep)

(07.00)

+£21.7bn

+£22.0bn

DR

UK

MPC’s Ramsden speaks on policy

(13.10)

Thu 22nd

UK

MPC’s Haldane opening remarks

(09.30)

UK

MPC’s Bailey on sustainable finance

(10.25)

Fri 23rd

UK

GfK Consumer Confidence (Oct)

(00.01)

-25

-28

-30

UK

Retail Sales Inc. Fuel (Sep)

(07.00)

+0.8%(+2.8%)

+0.3%(+3.7%)

+1.5%(+4.6%)

DR

UK

IHS Markit/CIPS Comp. PMI (Oct, Flash)

(09.30)

56.5

53.9

53.8

DR

UK

IHS Markit/CIPS Manu. PMI (Oct, Flash)

(09.30)

54.1

53.2

54.0

DR

UK

IHS Markit/CIPS Serv. PMI (Oct, Flash)

(09.30)

56.1

53.8

52.5

DR

Selected future data releases and events

Thu 29th

UK

M4 Money Supply (Sep)

(09.30)

-0.4%(+12.1%)

DR

UK

UK Economic Sentiment Survey (Oct)

(10.00)

83.0

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

-19.8(-21.8) (Q2)

-2.5(-2.1)

-19.8(-21.8)

+15.6(-9.5)

+1.3(-8.4)

(+1.5)

(-10.4)

(+6.0)

(+4.5)

CPI inflation

(+0.2) (Aug.)

(+1.7)

(+0.6)

(+0.6)

(+0.6)

(+1.8)

(+0.9)

(+1.3)

(+1.6)

ILO unemployment rate (%)

4.5 (Aug)

4.0

4.1

4.6

5.8

3.8

4.6

6.8

6.8

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 (%)

0.17

0.36

0.17

0.25

0.15

0.83

0.15

0.15

0.15

$/£, end period

1.29

1.24

1.25

1.29

1.35

1.33

1.35

1.35

1.35

Euro/£, end period

1.10

1.14

1.11

1.12

1.13

1.18

1.13

1.13

1.13

Sources: Capital Economics, Refinitiv

* Assumes that the current COVID-19 restrictions are tightened somewhat and last until April 2021. Assumes the UK and the EU agree a slim trade in goods deal by the end of the year. (See here.)


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