UK: Recovery is set back further by either more COVID-19 restrictions or a no-deal Brexit

The possibility of even tighter COVID-19 restrictions and of a no deal Brexit at the end of the year mean there’s a risk that the recovery goes into reverse. What’s more, as some of the government’s support measures expire, this next phase of the recovery will be more painful for households and businesses. That’s why strategists at Capital Economics think the Bank of England (BoE) will expand QE by a further £250 B by the end of 2021 and won’t raise interest rates above 0.10% until 2025.

“The possibility of more restrictions to contain the spread of COVID-19 and of a no deal Brexit mean the risks to our GDP forecasts lie on the downside. We think that the combination of an extra £250bn of Quantitative Easing and of interest rates being no higher than 0.10% for five years will keep gilt yields at historic lows.”

“The pace of the rebound in GDP from the 26% fall triggered by the initial COVID-19 lockdown was impressive. But in response to the new COVID-19 restrictions, we have revised down our forecasts. We now think that GDP won’t rise at all in the last three months of the year and won’t get back to its pre-crisis peak until the end of 2022.”

“As many arrangements have been made, the gap between a Brexit deal and a no deal has shrunk. We estimate that a ‘cooperative’ no deal, in which the UK and EU work together to minimise disruption, would mean GDP in 2021 is about 1.0% lower than otherwise. In an ‘uncooperative’ no deal, in which there is no collaboration, GDP may be about 2.5% lower. Either would set back the UK’s recovery from the COVID-19 crisis relative to other economies.”

“The unwinding of some of the government’s temporary support means that households and businesses will soon feel more of the pain. Although the government’s new Job Support and local lockdown furlough schemes will cushion some of the blow from the end of the national furlough scheme, the jobless rate will probably still rise from 4.5% in August to almost 8.0% during next year.”

“The subdued economic recovery probably means that in 2022 inflation will settle closer to 1.5% than the 2.0% target. We doubt the Bank of England will cut interest rates below zero in the next 6-12 months. But our forecast that it will expand QE by a further £250bn and keep interest rates no higher than 0.10% until 2025 explains why, unlike others, we don’t think gilt yields will rise.”

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