The UK economy should rally strongly from spring thanks to the roll-out of Covid-19 vaccines and supportive fiscal policy, according to analysts at Goldman Sachs International.
When England went into national lockdown on 4 January, it meant all four UK nations had imposed the restriction to control the spread of a new Covid-19 variant and prevent hospitals from being overwhelmed.
And although vaccines are being rolled out, the latest lockdown – due to be reviewed in mid-February – will likely see GDP contract by 1.5 per cent, according to Goldman Sachs analysts Sven Jari Stehn and Nikola Dacic.
The pair said that while conditions in this lockdown are lighter than those imposed last March, they are tighter than what was seen in November and will last for longer than one month.
There was anaemic economic growth of 0.4 per cent in October and a likely partial recovery in December of 1.5 per cent. However, this was believed to have contracted by 3.6 per cent in November.
This means the UK economy likely shrank by 1.2 per cent during the fourth quarter of 2020 and with a further contraction anticipated in Q1, the UK will enter into a double-dip recession.
And while the analysts anticipate that a sufficient number of vaccinations will have been carried out to end the current lockdown from mid-February, there are risks skewed towards a larger contraction due to the unpredictability of the new strain and the possibility of extended restrictions.
However, the pair said they believe the economy will rebound strongly from Q2 for several reasons.
First, UK activity remains significantly below pre-coronavirus levels, which is due to its greater reliance on Covid-sensitive consumer spending than its global peers.
Second, Stehn and Dacic noted the UK is better placed to benefit from a vaccine roll-out than other countries
“The initial roll-out of the vaccine has been slower than we had expected, with around 1.3 million people vaccinated to date,” the Goldman Sachs analysts noted. “That said, the recent approval of the Oxford/AstraZeneca vaccine is encouraging and the UK government has secured a large number of treatments for 2021.
“Although the roll-out will likely be slower than our earlier estimates, we expect 50 per cent of the population to be vaccinated in Q2 with at least the first shot, unlocking significant services spending.”
Thirdly, the Goldman Sachs analysts highlighted strong levels of fiscal support for the economy.
“The government extended the furlough scheme in December, which is likely to cushion the labour market hit from the renewed lockdown quite effectively until sufficient immunity has been achieved,” they said.
“Moreover, chancellor Rishi Sunak announced earlier this week that firms in those sectors of the economy hardest hit by the new lockdown will receive a fresh support package worth £4.6bn, providing grants to companies to help keep them afloat until the spring.”
Given a potential contraction in economic activity and the elevated risks around the outlook for the virus, Stehn and Dacic expect the Bank of England to provide additional monetary easing in the coming months but keep rates at current levels rather than dipping into negative territory.
“Although the third lockdown has clearly pushed up the chance of bank rate-cuts, we believe the Monetary Policy Committee will more likely than not keep rates on hold,” they said.
“While the economic case for a rate-cut in February seems most compelling, the Monetary Policy Committee’s communication on its operational feasibility has been limited.”
Although a cut in May is possible, they continued, it is likely that the Monetary Policy Committee hold interest rates until a time when the vaccine roll-out has made significant progress, restrictions have been lifted notably and the economy starts to rebound.
“We therefore think the MPC is more likely to keep rates on hold unless the vaccine-driven rebound in activity disappoints,” said Stehn and Dacic.
However, the Monetary Policy Committee could pick up the pace of gilt purchases at its February meeting in a bid to absorb additional issuance associated with the government’s fiscal measures due to be unveiled in the March budget.
As such, the investment bank remains optimistic about the UK outlook beyond the predicted contraction in economic growth during Q1.
Stehn and Dacic said the bank is forecasting a strong rebound for the economy as Covid-sensitive industries begin to normalise in the second quarter.
They continued: “As a result, we now expect real GDP growth of 5.6 per cent in 2021 and 6.4 per cent in 2022, and maintain our projection that the UK economy will return to its pre-Covid level in Q2 2022.”