Tim Wallace assesses the central bank’s forecasts for jobs, lending, negative rates and the prospect of a rapid V-shaped recovery
Three months ago, the Bank of England would not even make a forecast about the economy. Such was the scale of the pandemic and the lockdown’s impact that the City of London’s greatest financial institution was not prepared to nail its flag to any particular numbers.
Instead it came up with a “scenario” to give an idea of the cost. But that was in May. Now Andrew Bailey and his economists have gathered enough information to piece together a forecast. It is remarkably chirpy, at least by the standards of this most unusual of years.
This is what we learned from August’s Bank of England updates.
When Covid struck, economists hoped the recession would follow a “V” shape: a rapid crash in lockdown, then an equally rapid recovery as normality returned. As the severity of the pandemic became clear, this gave way to fears of a much longer crunch.
Yet now the economy is reopening, the Bank appears hopeful something like a “V” could take place. A strong rebound is happening in some parts of the economy. Consumer spending is back within 10pc of “usual” levels, up from a drop of 30-40pc in lockdown.
The housing market has “returned to close to normal levels”. Most furloughed staff are back at work.
The Bank thinks GDP dropped by just over 20pc from peak to trough, rather than almost 30pc anticipated in its May scenario. That translates to a fall in GDP of 9.5pc over 2020 as a whole, rather than 14pc as per May.
But the bigger drop was expected to be followed by a 15pc rebound in 2021. Now the rise is expected to be just 9pc, indicating a lop-sided “V”, taking longer to return the economy to its pre-Covid size.
The struggle to recover comes in two key parts. Firstly, it will take time for demand to return. People still fear the virus. Those who lose, or fear losing, their jobs will cut spending.
Secondly, the economy’s underlying capacity is taking a hit. Not every business or even industry will recover. With lower investment and innovation, the Bank expects the capacity of the economy will still be 1.5pc lower at the end of its three-year forecast than before the outbreak.
Joblessness is another threat. The Bank expects unemployment to hit 7.5pc this year, which is less severe than the financial crisis and short of the 9pc previously anticipated, but still a fearsome increase from below 4pc before Covid-19 arrived.
It will fall to 6pc next year and only come close to pre-pandemic levels at 4.5pc in 2022.
This forecast has been upgraded, but still shows a major hit to the economy. Analysts are sceptical. George Buckley at Nomura calls it “too optimistic”. Kallum Pickering at Berenberg Bank says it will take until 2023 before the economy gets back to its late-2019 size, more than a year after the Bank of England’s forecast.
So what more can the Bank do to boost the economy if growth falls short of expectations? Negative interest rates could be one answer.
The Bank’s analysis in the Monetary Policy Report listed a series of reasons why this could be a bad idea, as it potentially harms bank lending.
“As a result, negative policy rates at this time could be less effective as a tool to stimulate the economy,” said the analysis.
Yet Bailey indicated it was already in the Bank’s “toolkit”, suggesting it was ready for use if and when he deemed it appropriate.
He said it might be best to go sub-zero during the recovery, rather than at the peak of a crisis.
Economists at Citi expect the Bank to take rates to zero in November, add another £50bn to quantitative easing, and then go negative in 2021.
Keep on lending
Banks are under clear instructions to keep on lending. They face credit losses of up to £80bn, as some businesses and households will struggle to repay their debts, but the Financial Policy Committee told lenders they still have plenty of capacity to dish out loans. It estimates lenders could handle a recession twice as big as this, based on last year’s “stress tests” of their financial buffers.
On top of that, family finances are in a better position than they were going into the credit crunch. More pressingly, the Bank wants to make sure financial markets can handle big economic shocks without having to rely on enormous injections of liquidity such as that seen in March.
Tensions have calmed in recent months, but “underlying vulnerabilities remain and disruption could resurface in the face of certain triggers. There could also be an amplified tightening of credit conditions in the event of a large wave of downgrades of corporate bonds or leveraged loans”.
That is the next big risk to watch, for big businesses, the institutions which lend to them, and so the economy as a whole.
The Bank of England’s headquarters in the City of London. The central bank has issued a relatively upbeat analysis of the UK’s economic picture, compared with May