COVID | Europe | Fiscal Policy | Monetary Policy & Inflation | UK
The seasonal rise in Covid-19 cases and the revealed reaction function creates a gloomy tightening trend that already smashed my forecasts for the winter. However, the UK government exceeded even my bleakest expectations by announcing another nationwide lockdown on Saturday. That is a material level-shift strengthening of restrictions, consistent with other European nations but contrary to the UK’s preceding guidance. Localised measures are no longer deemed sufficient, so a heavy-handed national approach is now set to run from 5 November to at least 2 December.
Although the government is deploying the same slogan as in the first lockdown, there are some differences that make the latest round less severe. Most significant on paper is the ongoing opening of schools, which will save parents from having to leave their day jobs to moonlight as teachers. The guidance for workplaces is similar but likely to be interpreted less stringently this time. Work gained a stigma during the first lockdown such that people ceased even when unrequired. Now, aided by Covid-secure workplace investments, offices are better prepared, and the public mood is unopposed to their use.
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Summary
- The UK government followed other European states into a sweeping nationwide lockdown. Such an aggressive response is more severe than I assumed, so I am downgrading my forecast again to contain an even deeper winter recession.
- Additional fiscal support is slim but should postpone the bulk of the unemployment rise again. Deficits are also raised through lost revenue.
- Monetary policy is likely to continue absorbing the issuance and be ready to go into overdrive again if the gilt market breaks.
The seasonal rise in Covid-19 cases and the revealed reaction function creates a gloomy tightening trend that already smashed my forecasts for the winter. However, the UK government exceeded even my bleakest expectations by announcing another nationwide lockdown on Saturday. That is a material level-shift strengthening of restrictions, consistent with other European nations but contrary to the UK’s preceding guidance. Localised measures are no longer deemed sufficient, so a heavy-handed national approach is now set to run from 5 November to at least 2 December.
Although the government is deploying the same slogan as in the first lockdown, there are some differences that make the latest round less severe. Most significant on paper is the ongoing opening of schools, which will save parents from having to leave their day jobs to moonlight as teachers. The guidance for workplaces is similar but likely to be interpreted less stringently this time. Work gained a stigma during the first lockdown such that people ceased even when unrequired. Now, aided by Covid-secure workplace investments, offices are better prepared, and the public mood is unopposed to their use.
Overall, I am downgrading my GDP forecasts again following the lockdown announcement by 1.5pp in Q4 to a fall of 3% QoQ. That weakness is focused in November with only a partial rebound in December, owing to the likelihood that most measures are extended by at least a fortnight. I assume a slight further tightening again after Christmas before easing in the Spring.
So far, the government has announced little financial support to businesses, many of which the pandemic has already beaten to the brink of bankruptcy. A month-long extension of the furlough scheme was the only aspect announced alongside the lockdown. Whereas furlough initially cost about £10bn a month, I assume it will be nearer £7bn this time around. The difference is partly because of redundancies already being served in some quarters but also because the pre-Christmas trade will be crucial for those that have adapted for online sales. Even without any extension to the lockdown, it seems highly likely that furlough will run for at least two months. Will the government really want to give the gift of widespread redundancy notices for Christmas?
Such stimulus is a drop in the ocean compared with the wider destruction to revenues and other spending streams. Borrowing shouldn’t be noticeably worse in 2020-21 following some favourable revisions and the fact that £10bn is a mere rounding error nowadays. Another £15bn increase in the discretionary stimulus that I assume for this year ‘only’ takes the PSNBx to £335bn in my forecast. However, the aftermath of the renewed round of economic destruction continues to hit 2021-22 much more, in my view, with borrowing over £100bn higher than the OBR assumed in July, at £265bn.
The lingering damage to the economy and sustained elevation of gilt issuance is likely to keep pressure on the BoE to buy up the excess, lest it triggers undesirable portfolio rebalancing effects. The BoE would justify that as a response consistent with meeting the MPC’s mandate rather than outright monetisation, which isn’t what the MPC is doing here. As such, the additional £15bn of borrowing for the furlough scheme does not get mechanically added to the purchase programme for the winter. Maintaining the same historically elevated run rate still looks like the most likely approach to me, albeit with an increased risk of the sort of market misfunction that might prompt the MPC to supercharge its scheme again.
Phil Rush is the Founder and Chief Economist at Heteronomics, an independent macroeconomic research consultancy specialising in the UK economy. Prior to this, Phil spent 10 years on the sell-side, with his previous role being at Nomura as a Senior European Economist.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)