Sunday, August 09, 2020
V, W or Aargh? It depends on the virus - and on jobs
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt.

When the economy has been hit by as profound a shock as Covid-19, and the unprecedented lockdown measures adopted to limit its spread, we should take comfort where we can. The Bank of England, which gave us its latest forecast on Thursday in its quarterly monetary policy report, offered a modicum of such comfort.

On the basis of its new forecast, we no longer have to look at the early 1700s, the time of Queen Anne, the War of the Spanish Succession of 1706 and the Great Frost of 1709. If the Bank is right, and the economy shrinks by “only” 9.5% this year, it will merely be the worst since 1921, when it shrank by 9.7%. Anybody who talks about the roaring twenties, as some over-enthusiastic tabloids did not so long ago about the 2020s, has to remember that they did not roar last time in Britain.

The Bank, which in an “illustrative scenario” in May suggested that gross domestic product (GDP) could fall by 14% this year, hence the early 1700s’ comparisons, is not yet putting out the bunting. The UK’s recession this year is predicted to be worse than that of the eurozone, down 8%, and America, down 5.75%.

It also provides a health warning that would grace any cigarette packet or box of pills, noting that the outlook “will depend critically on the evolution of the pandemic, measures taken to protect public health, and how governments, households and businesses respond to these factors” and that its “projections assume that the direct impact of Covid-19 on the economy dissipates gradually over the forecast period”.

Those are the key assumptions for the Bank, and for other so-called V-shapers like me. It does not help when people talk about a second wave of Covid-19, because that is usually associated with flu outbreaks, which are more severe in the winter. This coronavirus, currently raging in very hot countries, does not appear to be weather-dependent. Even so, if easing lockdown means a return of the infections and deaths, to the point where lockdowns have to be reimposed (and if there are enough local lockdowns you get many of the effects of a national lockdown) that is bad news for the recovery.

On the assumption of a gradual dissipation of Covid-19, as has happened with previous pandemics, the recovery is both rapid and dramatic. After a huge 21% GDP fall in the second quarter, the Bank predicts an extraordinary 18% in the current third quarter. Both represent record-breaking quarterly changes, by a very large margin.

Similarly, after this year’s 9.5% fall, the economy grows by 9% next year, according to the Bank, and gets back to where it was at the end of 2019, before we knew what was coming, by late 2021. That, as Simon French of Panmure Gordon points out, would represent the most rapid recovery in 50 years.

It would also underline the highly unusual nature of this recession and recovery. We have the deepest recession in nearly a century but the downturn happened in just two months, March and April, as lockdown was imposed. Assuming the June GDP monthly GDP figures this week show a rise (the Bank expects a 9% increase on the month), the economy’s journey out of the low point will be confirmed.

Whether it continues depends, as noted, on the virus and the avoidance of a disruptive Brexit. That deserves a piece on its own but most observers expect a compromise, if limited, trade deal in the autumn. I shall return to that.

It also depends on the labour market, and here the Bank has done some invaluable work. The furlough or job retention scheme has been a huge government intervention but the Treasury and Her Majesty’s Revenue & Customs (HMRC) have little information on how many people are currently covered by it, as opposed to the cumulative 9.6m total of employees who have benefited from it at some stage.

The Resolution Foundation think tank has done some useful digging, and now so has the Bank. It estimates that, on average, 6m people were furloughed at any one time during the April-June quarter, and that numbers peaked at over 7m in May. This quarter, July-September, it thinks that the average number of people furloughed will come down to 2m, dropping further to 1m in October, the scheme’s final month. The Bank’s decision maker panel, the latest results of which were also out on Thursday, revealed that at 18% of employees were furloughed in July, down from 30% in June.

That informs the Bank’s view of unemployment, which is less scary than others. It sees unemployment peaking at 7.5% later this year, equivalent to about 2.6m people. There have been projections which suggest that the jobless total could reach 3.5m or 4m.

Bad though a near-doubling of unemployment would be, it would be better than it could have been. I have written before that success for Rishi Sunak’s furlough and other schemes will be keeping unemployment below 3m. Any loss of jobs is unwelcome, but if the Bank is broadly right the rise in unemployment will probably not trigger a big downturn in spending, which would undermine the recovery, later in the year.

There was a lot in the Bank’s new report. It is considering whether there may come a time when it should adopt negative interest rates, as other central banks have done, but appears sceptical, suggesting that there are reasons to doubt their effectiveness in the current situation. They might not work as effectively as a traditional cut in interest rates and they could hit household and business confidence.

This produces a curiosity in its forecasts. While the Bank’s steer was against negative interest rates, though not entirely ruling them out, the market interest rate assumptions it uses to prepare its projections has Bank rate going marginally negative, by 0.1%, next year and for the following two years.

Is the Bank trying to have its cake and eat it, as one analyst suggested? A little, but as you might expect, the difference in the economic outlook between an interest rate of 0.1% and one of -0.1% is very small. The Bank’s V-shaped recovery does not depend on it.

But the debate over negative rates has not gone away. Were the Bank to adopt them at some stage it would be an indication that the other tools in its kit, notably quantitative easing and ultra low but positive interest rates, were not doing enough. They would also be an indication that the economy was not bouncing back as strongly as the Bank currently expects.