UK Economic Update

Early signs in Q3 pointed to a recovery, which accelerated in June, buoyed by the release in business and economic activity, partly supported by pent-up consumer demand and growing confidence from the drop-off in COVID-19 cases. This, combined with the additional economic policies announced in July (e.g. Eat Out to Help Out, the temporary cut in VAT for the hospitality and leisure sector), helped boost spending.

There are some signs that the recovery appears to be losing momentum after the initial sharp recovery in June and July. While the new restrictions outlined by the Prime Minister affects fewer sectors of the economy than in March and are therefore less disruptive, prolonged uncertainty could dampen business and consumer confidence and constrain the recovery. We therefore maintain that the recovery path is likely to resemble a ‘kinked-V’, which means that after a swift bounceback, the economy will take time to recover fully to pre-crisis levels. 

Under our “contained spread” and “further outbreak” scenarios, the UK GDP is expected to contract by between 11% and 12% in 2020 before returning to growth of around 10% and 4% in 2021. 

Risks are however weighted to the downside, as there is still significant uncertainty over the pace and path of the recovery, especially in light of the growing number of cases which have led to another round of limited national restrictions, the degree of economic scarring and the outcome of the UK-EU trade negotiations.

We anticipate that most sectors will return to growth in 2021, including hard-hit sectors like retail and hospitality as they recover from a low base in 2020. The lifting of travel restrictions next year would boost the sector, but this is nevertheless subject to considerable uncertainty - the continuation of travel restrictions and lockdown measures would constrain growth, as assumed under our further outbreak scenario.

We expect the construction sector to grow in 2021, partly driven by fiscal measures to boost infrastructure investment. Similarly, adaptations made by manufacturing businesses should enable businesses to continue operating to support the recovery. Unlike the rest of the transport and storage sector, the logistics sector is likely to recover more strongly, driven by the acceleration of e-commerce.

We expect inflation to remain somewhat below target for the rest of 2020 in our main scenario, mainly due to the continued impact of energy prices, the temporary reduction in VAT as well as subdued wage growth. Inflation is then expected to pick up again in 2021 as these effects unwind. The reversal in spare capacity, and the rise in consumer demand as economic activity recovers and wage growth picks up again will feed through to an increase in domestic price pressures.

Public sector finances are increasingly coming under pressure, due to the significant increase in government spending to support the economy during the crisis, as well as lower tax receipts. The total cost of the government’s fiscal support so has far reached £280 billion (10% of GDP). By comparison, the total stimulus package in response to the 2008-09 financial crisis amounted to 2.1% of GDP, or £42 billion. The size of the fiscal response means that debt as a percentage of GDP rose to just above 100% of GDP, its highest level since March 1961.

Our projections, reflecting the higher cost of the fiscal support package and lower economic growth scenarios, imply a sharp rise in the budget deficit to around 19-22% of GDP, but much of the rise will reverse in 2021/22m with the deficit falling to around 6-12% of GDP.