UK - Winter outbreak and Brexit to delay 2021 recovery

Pandemic leaves devastating gap

The pandemic saw GDP contract by 19.8% in Q2 – the sharpest quarterly fall on record and one of the worst worldwide. Despite a 15.5% rebound in Q3, output remained 9.7% below its end-2019 level. The return to national lockdown in Q4 – albeit shorter and less intense than before – looks likely to see a further drop in GDP by year-end. We forecast GDP at -11.2% in 2020. Exhibit 1 illustrates how this compares with previous recessions.

Exhibit 1: GDP comparison with prior recessions

We predict a rebound in 2021. With lockdown ending in December, 2021 should see an initial strong rebound, but we are mindful of risks. While there are glimmers of hope that new virus cases are slowing, restrictions will not be fully removed in December and renewed deterioration is possible in January. We expect mass vaccination from around mid-2021, offering the prospect of an economic boost later in the year. While distribution prospects are daunting, demand for a vaccine appears high. Earlier inoculation of vulnerable and essential workers should also provide economic protection against a renewed pick-up in virus cases.

The UK will complete Brexit this year. At the time of writing, the UK and EU were yet to agree a post-transition trade deal, although we expect one soon. This would avoid further separation costs and allow wider agreements, including equivalence for some financial services. Yet any agreement would be a bare-bones deal and estimates suggest that even a comprehensive deal would cost the UK 4.9ppt of GDP, compared to 7.6ppt in the event of no deal¹ . Around 5% of British business reports being fully prepared for new trading conditions² . We expect disruption at ports to block exports, build inventory and curtail production. The UK exports around 9.5% of GDP in goods to the EU in a normal year, so costs could be high. A ‘no deal’ outcome would be worse and could lower GDP growth by a further 1ppt in 2021.

We are cautious in our outlook for growth in early 2021 and pencil in a 4.6% rise for the year as a whole – the fastest since 1997 – but this would still leave GDP 4% lower than end-2019. A vaccine in H2 2021 should help recovery in 2022, when we forecast 6.5% growth, leading activity to regain end-2019 levels by end-2022. With supply capacity still rising, even then we would forecast excess supply. However, permanent losses associated with Brexit and scarring from the pandemic should see the output gap close in 2024.

Spare capacity is likely to be most obvious in the labour market. The furlough scheme has supported the economy and unemployment has only risen to 4.8% to date. However, it has also disguised the amount of labour market slack and with the scheme extended until March, this will continue into next year. For now, we expect unemployment to reach 7.5% around mid-2021 and retreat to 5% by end-2022.

The extension of the furlough scheme and other support measures will be key to ensuring a pick-up post-lockdown. Yet to drive recovery, a medium-term package of growth-enhancing measures is likely to be necessary. We expect a material fiscal easing in next year’s Budget. Yet with a deficit approaching 20% of GDP and debt exceeding 100%, the Treasury will also consider longer-term consolidation.

The Bank of England (BoE) will also provide support. Following a further £150bn of QE in November, the BoE forecasts inflation at 2% from mid-2021. We consider only a brief rebound and inflation to average 1.5% in 2022. Further stimulus looks necessary to return inflation to target. We expect more QE, with a further £75bn in Q2 2021, extending purchases into 2022. Yet we doubt the merits of negative rates and do not expect the BoE to experiment with them as the foundations for recovery take shape from mid-2021.