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Economic Research: U.K. Recovery: Delayed But Stronger

Table

S&P Global Ratings' U.K. Economic Forecasts
2018 2019 2020 2021 2022 2023
GDP 1.3 1.4 -9.9 4.3 6.8 2.2
Household consumption 1.3 1.1 -10.7 3.7 6.5 2.2
Government consumption 0.6 4.0 -5.7 5.4 7.5 2.0
Fixed investment 0.4 1.5 -8.7 6.8 6.8 1.0
Exports 3.0 2.7 -16.7 2.2 8.6 2.2
Imports 2.7 2.7 -18.1 6.4 10.4 1.5
CPI inflation 2.5 1.8 0.9 1.3 2.0 1.8
Unemployment rate 4.1 3.8 4.5 6.3 5.5 4.4
10-year government bond 1.41 0.88 0.32 0.37 0.52 1.08
Bank rate 0.60 0.75 0.23 0.10 0.10 0.10
Exchange rate (euro/GBP) 1.13 1.14 1.12 1.11 1.12 1.13
Sources: ONS, BoE, S&P Global Ratings.

The U.K. economy started the new year facing yet more tests of its resilience. The whole country is once more under a tight lockdown to curb the spread of COVID-19, which accelerated from mid-December last year and risked overwhelming the health system. The number of new cases has now dropped from its latest peak but remains high compared with April's levels last year. What's more, as of January, the U.K. as a whole has fully and finally left the EU (with some exceptions for Northern Ireland), reducing its ties from single-market membership to a free-trade agreement. And that deal is mostly limited to goods trade and even there comes with some restrictions. This seismic change has already started to shape the economy and will bring with it a lot of growing pains for years to come. Yet, the impact of pandemic lockdowns and the recovery will dominate economic performance this year and next.

In fact, the single most important factor behind our downward revision of GDP growth in 2021 to 4.3%, from 6% earlier, is the severe and protracted latest lockdown. The setback we expect for the first quarter could push the economy back to 12% below pre-COVID levels, from 6.5% in December. Still, conditions for a strong recovery remain in place. Indeed, the U.K.'s swift progress with its vaccination program (now in a race against the spread of viral variants) is very good news in this regard, complemented by continuing fiscal and monetary support for households and businesses. The recovery is not forgone, only postponed. We expect a strong rebound to set in from the second quarter, which will spill over into 2022 with growth of 6.8% (5% earlier), before slowing to 2.2% in 2023 as momentum from the recovery fades.

The economy is adjusting to lockdowns

The current lockdown is at least as restrictive as the first one, which left the economy operating 24% below normal levels at end-April 2020 (compared with December 2019). According to the government's roadmap, the exit from it will also be gradual, with a first significant easing of restrictions (the opening of non-essential retailers) only at the end of March this year. This suggests the current lockdown could cause at least as much damage in the first quarter of this year. However, this is unlikely to be the case, in our view, for several reasons.

Chart 1

image

First, and importantly, businesses are now better prepared for, and have adapted to, operating under lockdowns. Indeed, the data confirms that the impact of subsequent lockdowns on economic activity decreases over time. This applies across U.K. sectors, but especially to construction where activity has been recovering strongly from its earlier dramatic decline. Purchasing managers indices now also show signs of resilience in February, after material weakness in January.

Chart 2

image

Second, adaptation can be seen in consumer behavior, too. For example, more households now are becoming more comfortable buying a wider range of goods and services online, or by substituting restaurant visits with more lavish meals at home. But despite greater resilience, household spending is once more suffering from the lockdown. Debit and credit card spending data from the Bank of England shows a household spending shortfall of 25% in early February, compared with normal times. This came after fall of 35% in January, which reflected both the usual post-Christmas hangover, but also a correction after the surge in panic buying at the end of last year. But despite the sizable decline at the beginning of the year, these numbers still compare favorably with the 44% average shortfall in April 2020 and support our view of diminished impact.

Conditions For A Strong Recovery Remain In Place

A third important reason why the impact this time round will be less severe is that fiscal and monetary policy support measures were already in place before the third lockdown began. Although authorities were quick to deploy measures at the onset of the crisis early last year, implementation and uptake took time, which caused delay in effective support.

To a large extent because of the support measures, financial conditions have generally remained very favorable. The government, in its March 3 budget, has also just extended key measures to support the economy until the end of the lockdown. This ongoing and extended support will help protect the structure of the economy during the recovery while demand is still weak.

The tax deduction to spending for certain capital goods in the chancellor's budget should also add to the growth impetus. However, its main effect will come by bringing investment forward, rather than boosting it over a longer horizon. And the need to import many of the investment goods will dampen growth.

Chart 3

image

Fourth, the U.K. is making rapid progress with its vaccine program and is ahead of its peers. More than 42% of the adult population, compared with 8% on average in the EU, have now received at least one jab, and the country is well on track to achieve widespread immunization by midyear. Until then, there is still of course the risk that new strains of the virus continue to emerge, limiting the effectiveness of the vaccination campaign and setting back the timelines for recovery. To curb that risk, the government has decided it will lift restrictions contingent on success in controlling the pandemic, with late June being the earliest moment for a return to a semblance of normal. But with that caveat, widespread immunization should boost consumer and business confidence and support a strong and sustained recovery growth from midyear.

Household Spending To Kick In From The Second Quarter

Government support for households via the furlough scheme and support to the self-employed has helped to preserve households' spending power, and will, after its extension, now continue to do so until September. Just under 5 million workers--or 14% of the workforce--benefitted from the scheme in January, up from 4 million in December. Moreover, by restricting spending options, the lockdown itself has helped amass large household savings. Even after the surge in consumer spending in the third quarter last year, the household savings rate was still at a high 17%, compared with 6.5% on average over 2018-2019, and we think the rate has remained high or perhaps rose in the first quarter amid fresh restrictions. That means an ample cash buffer will be available to fuel household spending stymied by pent-up demand once restrictions start loosening.

The government's roadmap for the lockdown exit said little about when and to which extent travel restrictions might be lifted. Although holiday bookings suggest strong pent-up demand for holidays abroad, it remains unclear whether travel plans can be realized in the summer. Should these restrictions not be lifted in time for the peak season, consumers would turn to staycations or domestic tourism, which would further boost growth in the second half of the year in view of the U.K.'s usually large tourism deficit.

Chart 4

image

Having said that, the skew of higher savings to middle and higher incomes will somewhat mute the boost from accumulated savings. People with lower incomes--often in lower-paying face-to-face services jobs and therefore most exposed to the pandemic--had little opportunity to save much if any of their reduced incomes (from furlough or self-employed support), with a large share spent on housing and food.

At the same time, unemployment will rise later this year as employers' contributions to the furlough scheme increase over time, and as some businesses fail despite support during the recovery when economic activity is still weak. This will weigh on the recovery by adding to the current slack in the economy, especially the labor market, which is not yet visible in very low headline unemployment rates (5.1% in December) but already in record low vacancies, a high unemployment claimant count, and low payroll numbers.

Life After Brexit

Adding to pandemic woes, as of January the U.K. has now fully left the EU and the trade relationship of both sides is now governed by the Trade and Cooperation Agreement (TCA) reached late last year, which has introduced new rules for goods in trade and does away with most earlier provisions for trade in services.

Although Brexit itself is done and dusted, January 2021 marks only the beginning of the journey. It is true the economy had changed and was reorienting itself well ahead of the date, with many businesses preparing in anticipation. For example, some businesses relocated operations to the EU and held back investment spending in the face of uncertainty starting in 2016. This has reduced the base from which the economy can now grow in the future as well as the pace of this growth. But although the diminution of Brexit uncertainty should now help the economy to adapt to its new business footing, in many areas the TCA's full effects have yet to be seen. For example, the TCA provides for tariff-free trade into the EU only if goods satisfy the so-called rules of origin. The U.K.'s supply chains are highly integrated with the EU and across the world. When the cost of additional red tape and potential tariffs that come with the TCA are added in, will current supply chains still be viable? Importantly, how will the services sector fare without seamless access to the single market?

We are already hearing some anecdotal evidence about trade disruptions, especially regarding smaller U.K. exporters having trouble getting their goods into the EU. Some initial trade disruptions of this kind were to be expected and should dissipate as businesses and institutions on both sides adjust. But answers to the broader questions will come later as we learn more about the impact and as negotiations over the still missing parts of the deal continue. For now, our earlier assumptions about the impact of Brexit are still appropriate, in our view, and there is no significant Brexit-related change in this forecast, but it is likely we may need to amend our assumptions in the future.

A Novel Shock Brings More Than The Usual Risks To Forecasting

Uncertainty is inherent in any forecast, but never more so than now. The pandemic and lockdowns present a unique and novel shock not just to the economy and the wider society. Its exact repercussion both in the short and longer term are very difficult to assess, and in this regard brings significant risks to this forecast. For example, while we expect a strong consumer-led recovery, it is possible that consumer behavior has changed more permanently and that households will hold onto much more of their savings for precautionary motives than we expect, even after restrictions are fully lifted, reducing the pace of the recovery while also shifting the structure of the economy in unexpected ways.

S&P Global Ratings believes there remains high, albeit moderating, uncertainty about the evolution of the coronavirus pandemic and its economic effects. Vaccine production is ramping up and rollouts are gathering pace around the world. Widespread immunization, which will help pave the way for a return to more normal levels of social and economic activity, looks to be achievable by most developed economies by the end of the third quarter. However, some emerging markets may only be able to achieve widespread immunization by year-end or later. We use these assumptions about vaccine timing in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

This report does not constitute a rating action.

Senior Economist:Boris S Glass, London + 44 20 7176 8420;
boris.glass@spglobal.com

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