Last week’s UK GDP data underscored the scale of the economic damage wrought by the Covid-19 lockdown. The economy contracted by 2% in the first quarter of 2020, the sharpest quarterly contraction since the 2008 financial crisis.
The depth of the contraction is remarkable given that the lockdown was only implemented on 23 March. Activity was starting to tail off in the previous week. But in just two weeks, from the middle to the end of March, huge swathes of economic activity shut down. This was enough to drive a record 5.8% fall in GDP in March.
The speed and scale of the decline in activity is of a kind that might be expected in war or, in resource-dependent emerging economies, during deep crises (Libya and Venezuela have, for instance, witnessed double-digit declines in GDP growth in recent years).
The scale of the contraction in UK and international activity, and an only gradual easing of the UK lockdown, points to a weaker outlook for GDP growth. We are therefore downgrading our 2020 UK GDP forecast, with an expected contraction of 11.7% compared to a previous -6.8%. For 2021 we see the economy growing by 8.5%, up from a previous forecast of 6.5%.
Our 2020 forecast is at the low end of the current range of forecasts, which on average expect a contraction of 7.9% this year. However, the trend has been for forecasters to downgrade their numbers, with more recent forecasts consistently more pessimistic than earlier ones.
Following a 2% contraction in UK GDP in the first quarter we expect GDP to shrink by 19% in the second quarter. This reflects the impact of full lockdown measures in place until mid-May, which resulted in the halt of most non-essential activity, including the closure of schools.
My colleague Max estimates that in early May around one-third of the entire UK workforce were either furloughed or on Universal Credit, pointing to a huge impact on output. The lockdown has collapsed consumer spending, with Barclaycard reporting that credit and debit card spending fell by almost 40% in April. Spending on travel, entertainment and clothing and footwear have been especially hard hit.
From mid-May the government has announced a “conditional plan” for the gradual easing of the UK’s lockdown. In the second half of this month it will mean the return of some activity in manufacturing, construction and real estate. In June some schools will reopen, as will non-essential shops. This partial reopening will recover some activity from the trough reached during the full lockdown. Our forecast of a 19% contraction in GDP between April and June is therefore predicated on a gradual recovery in activity from mid-May. This contrasts with the Office for Budget Responsibility’s estimate that a full three-month lockdown would cause the economy to contract by 35% in the second quarter.
We expect the economy to continue to recover in the second half of the year. The government has indicated that some hospitality, accommodation and close-contact businesses like hairdressers could reopen in July.
Concerns about Covid-19 and a highly uncertain economic backdrop mean that many consumers are likely to remain cautious. Production may struggle with supply chain disruption, changes to processes required by social distancing and shifts in demand. Businesses seem likely to remain in defensive mode with a focus on cutting costs. A perception of increased risk is likely to weigh on travel and some leisure activities.
Assuming that a combination of testing, tracing and new treatments allow for looser restrictions to be maintained without a resurgence of new Covid-19 cases, we expect GDP to recover by 7.8% in July-September and by 4.2% in October-December. By normal standards these growth rates would count as being extraordinarily strong. Yet in the context of an economy that has been partially closed they represent a gradual return of normal activities. This is unlikely to happen quickly. By the end of 2020 we believe the UK economy is likely to be 10.8% smaller than at the end of 2019.
Our forecast assumes that a vaccine is not made available at scale in 2021, meaning a continuation of social distancing and quarantine. As people become more accustomed to this regime we see consumption activity recovering through 2021. Most people are likely to return to work, though subject to restrictions to limit crowding which would also apply to arts, sports and entertainment activities.
The catch-up process will run through 2021 and with quarterly growth continuing to run at above-normal levels as activity and expenditure reclaim lost ground. Yet even by the end of 2021 the economy may still be smaller than on the eve of the Covid-19 crisis.
Forecasting is a speculative activity, and rarely more so than today. We conclude with some brief thoughts on what might go wrong, or right, over the next year or so. The most obvious risk is of a second wave of cases requiring renewed lockdowns. The crisis may damage the growth potential of the economy, by, for instance, raising long-term levels of unemployment. The UK, as an open trading economy, would suffer if this crisis further damages globalisation and free trade.
Things could also improve faster than expected. The stringency of the lockdown is the key determinant of growth. To save the economy, without compromising health, we must find a way of controlling Covid-19 without locking down the economy. South Korea and Germany demonstrate how effective testing and tracing can help achieve this. The vast and unprecedented policy interventions of the last ten weeks could generate a faster snapback, with pent-up demand surging as restrictions are loosened.
But the much-talked about V-shaped recovery, in which activity quickly returns to pre-crisis levels, is looking less and less likely. The closure of great swathes of activity make a deep contraction in the current quarter inevitable. But growth is starting to resume and, with luck and the right policies, will gather pace.
Click here to subscribe to our daily briefing – the best pieces from CapX and across the web.
CapX depends on the generosity of its readers. If you value what we do, please consider making a donation.