Opinion: Goodbye v-shaped recovery?

In light of the latest forecasts from the Office for Budget Responsibility, Richard Dawson asks if we are letting our hopes become our expectation in respect of a v-shaped recovery from this economic crisis

The Government’s independent economic forecaster, the Office for Budget Responsibility (OBR), has published its latest fiscal sustainability report (FSR).

The analysis follows a similar release back in April, which claimed the coronavirus recession would be the worst the UK has faced for 300 years.

A lot has changed since April 14, but the underlying reality remains that the UK is on track for its largest annual GDP decline since 1706.

In the previous FSR, the public finances watchdog modelled a scenario where GDP shrinks by 35 per cent in the second quarter of this year and by 12.9 per cent in 2020 as a whole.

It has now revised those figures, in line with Office for National Statistics (ONS) data released this week (July 14), which showed that the UK economy was only 24.5 per cent smaller in May than it was in February.

I never thought I’d be using the word ‘only’ to describe UK output being reduced by a quarter, but relative to the 35 per cent decline that was forecast for Q2, it is an improvement.

In the latest FSR, the OBR has modelled three different scenarios – central, upside and downside – each of which points towards a GDP decline in excess of 10 per cent this year.

In the central scenario, the contraction is 12.4 per cent, with 10.4 per cent forecast in the upside scenario and 14.3 per cent in the downside.

While these estimates of the size of the contraction are a slight improvement on the April forecast, the OBR’s expectation for the recovery has unfortunately been revised to the downside.

Back in April, the forecast was for GDP to grow by 17.9 per cent in 2021. Now, in the central scenario, which is the sequence of events the OBR considers most likely, the bounce back is just 8.7 per cent.

The upside estimate is 14.5 per cent, whereas the downside figure is a meagre 4.6 per cent.

These numbers mean that, at best, the UK economy will not return to its late 2019 size until early 2021 or, at worst, until late 2024.

The central scenario predicts recovery by the end of 2022, with 3 per cent of real GDP permanently lost by 2025.

The biggest takeaway from the FSR is that the much hoped for v-shaped recovery is becoming less likely as time goes on.

Even the upside scenario, which is the only one that could be described as v-shaped, already looks optimistic, given the sluggish return to growth we saw in the ONS data for May.

In a month that saw parts of the economy grind back into gear, UK GDP grew by just 1.8 per cent. It will have to come roaring back in June and in the second half of the year to get close to the upside scenario.

PMIs and business barometers for June were encouraging, but so far, the information we have available does not point towards a rapid recovery in business activity.

It is still early days, but the OBR’s central prediction of a more protracted recovery that takes until the end of 2022, seems more plausible.

Under this scenario, unemployment is expected to rise to 8.8 per cent this year and 10.1 per cent in 2021. That’s more than double the near record low of 3.8 per cent achieved in 2019.

The last time more than 3 million people were unemployed in the UK was between 1982 and 1987, during the decline of heavy industries such as coal mining, shipbuilding and steelmaking.

Another area of concern is public sector net borrowing or the budget deficit.

Due to tax receipts being £133 billion lower in 2020/21 and public spending being £135 billion higher, as per the central scenario, the deficit could rise to £322 billion by the end of the financial year.

At 16 per cent of GDP, this would be the highest peacetime budget deficit in 300 years. As a point of reference, borrowing was just £25.5 billion or 1.2 per cent of GDP in 2019.

In summary, this FSR paints a picture of collapsing GDP, mass unemployment and ballooning budget deficits.

Where a v-shaped recovery is concerned, we could therefore be letting our hopes become our expectation.