The UK economy faces a challenging near-term outlook

Despite a speedy vaccination drive, a protracted lockdown means we are reducing our 2021 GDP forecast for the UK.

Thomas Costerg, Senior US Economist, Pictet Wealth Management

The UK economy faces a challenging near-term outlook

Facing a particularly challenging health crisis due to a new virus variant, the UK government has postponed the end of its national lockdown. Schools, for instance, are not set to reopen before 8 March. Shops and restaurants are likely to reopen later. This will result in additional economic harm in the near term, particularly to the services sector—even though ongoing government support, particularly a sizeable wage-guarantee scheme, will help prevent even worse damage.

We now expect consumer spending to rebound later than we had previously forecast, so we have trimmed our 2021 growth prediction for the UK economy from 6.7% to 5.5%. As a reminder, we expected the economy to have shrunk by a sizeable 10% last year. Our forecast for this year is still above the International Monetary Fund’s latest forecast of 4.5%, 1.4 percentage points lower than its previous forecast for the UK in October.

In line with our expectations for elsewhere, we still believe that UK activity will rebound sharply by the summer due to the release of pent-up demand and accumulated savings. This assumes the speedy UK vaccination drive does not get thrown off course by supply issues or another more malicious new variant of the virus. Meanwhile, post-Brexit EU-UK tensions remain high, and a number of logistical issues have appeared. The cross-Channel tensions have been further fuelled by controversies about vaccine supplies.

A downside risk is UK Chancellor Rishi Sunak’s against-the-current reluctance to contemplate keeping budget deficits elevated in the medium term. He has also hinted he might already be considering corporate tax hikes.

Unlike the European Central Bank, our central scenario is that the Bank of England will not cut its benchmark rate (which has been 0.1% since March 2020) to negative, but it remains a possibility. We think the Old Lady of Threadneedle Start would prefer to add more liquidity to the system through further bond purchases. Like elsewhere, the lines between strict monetary policy and indirect deficit financing are becoming blurred in the UK.

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