UK GDP – rising virus risks delay rebound

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● Worsening virus trends: The number of new daily SARS-CoV 2 infections has turned up sharply in the UK since the beginning of December. Reacting to rising infection numbers, the UK government has increased the restrictions across a number of key regions. Major economic centres in England such as London, Birmingham and Manchester are all now under so-called “tier 3” restrictions, which involve strict limits on travel as well as the closure of hospitality and entertainment venues and hotels. Such restrictions will likely persist into January or, at any rate, until the virus spread begins to reverse. After the administrations of Northern Ireland and Wales announced new lockdowns beginning on 26 December, the risk of a third lockdown across England has risen substantially.

● Not like spring: Incoming economic data suggest that the economic hit to UK Q4 GDP from the second wave of the COVID-19 pandemic will be a little less bad than we had initially expected. Despite the lockdown across England during November, data published today by the ONS showed that retail sales declined by just 3.8% mom. From a higher initial level, the November drop is modest compared to the 18.1% mom drop during the first lockdown in April. Although the composite PMI only picked up a little in December (50.7), partly reflecting rising virus risks, the data for November remained firm (49.0 versus 13.8 in April). For Q4, we now expect real GDP to shrink by 4.0% qoq versus an initial estimate of -5.5% on 2 November – ahead of the lockdown in England from 5 November onwards.

● Less rebound in Q1 2020: Despite the smaller-than-expected hit to the final quarter of 2020, the outlook for the start of the new year has become less bright. While the advent of warmer weather and progress with administering vaccines to the most vulnerable should help ease the virus risks towards the end of the first quarter already, the likelihood that harsh restrictions remain in place across the UK will hurt economic performance in Q1 2021. From 5.5% qoq previously, we now project that real GDP will grow by 3.0%. However, much of the Q1 loss will be made up over the course of the year as virus risks fade. In Q2 2021, we now project a gain of 6.0%, from 4.1% previously.

● Positive outlook: Despite the near-term risks and uncertainties related to the pandemic and Brexit, the medium-term outlook for the UK remains favourable. With luck, the UK and the EU will strike a deal shortly that will minimise the disruptions to the UK from leaving the EU Single Market and Customs Union on 31 December. Fading virus risks over the course of 2021 and a successful UK-EU deal should support confidence, spending and investment. Economic policy support can add an additional strong tailwind to growth momentum.

● Dialling up the support: Reacting to the rising virus risks, policymakers are once again enhancing the support to firms and households. Yesterday the Bank of England (BoE) announced that it would extend its Term Funding Scheme by six months to 30 June 2021. It follows the BoE’s decision in November to extend asset purchases until the end of 2021. On the fiscal side, Chancellor Rishi Sunak announced yesterday that the furlough scheme would be extended by one month until April. Sunak also decided to extend the government’s emergency loan schemes for businesses until the end of March 2021 instead of the end of January as previously planned.

● Forecast summary: Following the changes to the near term, our new annual projections are as follows: in 2020 we now project an 11.6% decline versus -11.7% before. Thereafter, we cut our 2021 call to 7.3% from 8.0% and raise our 2022 call to 4.9% from 4.3%. Our call that real GDP will return to its pre-pandemic level by Q4 2022 is unchanged.

Kallum Pickering

Senior Economist

+44 20 3465 2672

[email protected]

Disclosures

This material is intended as commentary on political, economic or market conditions for institutional investors or market professionals only and does not constitute a financial analysis or a research report as defined by applicable regulation. See the "Disclaimers" section of this report.

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