Bank of England warns 2020 could be the worst year for UK economy since 1706

May 7, 2020 @ 13:51 by Richard Dawson

At the latest meeting of its monetary policy committee (May 7), the Bank of England has warned that UK GDP could shrink by 14 per cent in 2020, which would be the worst year for the economy in more than 300 years.

The Bank decided to hold interest rates at 0.1 per cent and published an illustrative economic scenario to try and provide some context to its monetary policy.

The scenario is based on a number of assumptions about how the coronavirus pandemic will affect households, businesses, financial markets and fiscal policy.

While the scenario is conditional on a number of speculative future developments, it helps the Bank illustrate the likely impact of COVID-19 on the economy, an impact which by any standard, will be unlike anything we have seen in our lifetimes.

The headline figure of GDP falling by 14 per cent, the largest such decrease since 1706 according to the Bank’s own historical data, is accompanied a sharp rise in UK unemployment by the end of this quarter.

While it is likely that the Coronavirus Job Retention Scheme has limited the number of losses, the Bank still expects unemployment to more than double to 9 per cent by June.

The Bank predicts that GDP will fall by 3 per cent in Q1 2020, followed by a 25 per cent reduction in Q2. That second figure would be nearly double the largest quarter-on-quarter decline in recorded history (13.3 per cent in 1921).

One of the key conditioning assumptions made by the Bank in this scenario is that social distancing measures and Government support schemes remain as they are until early June, before being gradually unwound by the end of Q3.

It is also assumed that some companies will cease or scale back their operations for a time and that some of the spending foregone while social distancing measures are in place will be made up.

However, it is thought that lower confidence and higher uncertainty will persist for some time and dampen spending.

A rather more contentious assumption in the scenario is that the UK moves to a comprehensive free trade agreement with the EU on January 1 2021.

Other key figures outlined in the model include household consumption falling by 14 per cent (in line with GDP) and business investment falling by a quarter (26 per cent) this year.

Hideous as all of these figures are, the Bank’s long-term outlook is still fairly upbeat.

It is thought that the economy will recover quite rapidly in the second half of 2020, although not returning to its late-2019 size until the middle of 2021.

Under the scenario, after falling by 14 per cent this year, GDP is expected to grow by 15 per cent in 2021, in what has widely been described as a v-shaped recovery.

Moreover, key indicators on unemployment, inflation, consumption and business investment are also anticipated to recover quickly and in fact, the Bank thinks that the UK could bounce back from this economic crisis faster than it did from the 2008 financial crisis.

Part of its reasoning for the rapid recovery is that, unlike the last crash, Britain’s financial institutions have become much more resilient in recent years. The Bank stress tested major high street banks last year and concluded they could withstand a recession of this magnitude and keep the supply of credit open.

The 2008 financial crisis was so bad because it was followed by a credit crunch, wherein there was not enough liquidity in the financial system for banks to continue lending to businesses and consumers.

It is hoped that this time around, credit lines will remain open, preventing the long-term economic scarring associated with widespread business failures and redundancies.

But in its scenario, the Bank of England assumes that there will be no second peak of coronavirus infections, which at this point cannot be guaranteed.

A second lockdown, as has been widely reported, could cause far more economic damage than anyone on Threadneedle Street would like to contemplate.

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