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I get locked down, but I get up again…
26 Jan 2021
Despite the successful start to the UK's vaccination programme, new strains of the coronavirus pull at the British economy. More widely, global governments tackle their own Covid-19 challenges at a variety of rates. But promisingly, the global economy appears to have contracted less than initially predicted. Our economics team analyse this and more in the latest Global Economic Overview.
Summary
Global
Amid the gloom of lockdown in a UK winter, it is easy to focus on the negatives. The near-term battle against Covid has become harder, as new, more infectious, virus strains have emerged adding pressure on healthcare systems, thus prompting a tightening of social restrictions. As a result, we have downgraded our Q1 GDP forecast and we now expect quarterly contractions in output in the UK, the Eurozone and Japan. Yet the global economy seems to have contracted less than we thought in 2020. World trade and Asian economies appear to be recovering, the vaccine rollout is underway and further fiscal stimulus is on its way in the US and Europe. So in fact, our global growth forecast has been revised up, from 5.8% to 6.2% for 2021.
United States
Joe Biden is determined to unleash a material amount of fiscal stimulus. On the coattails of the $900bn package at the end of last year, the new President is planning to launch a $1.9trn programme next month. Furthermore, the Democrats aim to push their "Build Back Better" plan later in the year. Incoming Treasury Secretary Yellen has put forward a case to "act big." But narrow majorities in both houses of Congress are leading the Democrats to seek bipartisanship with Republicans, which may water down some of the proposals. Also, it is not clear how former President Trump’s second impeachment trial in the Senate will affect cross-party congressional dynamics.
Eurozone
In the Eurozone, Germany and the Netherlands have adopted stricter lockdown measures with curfews imposed in France. These measures will come at a cost to their economies, probably bringing about a double-dip recession again in Q4 and Q1 after the rebound last autumn. With vaccine rollout also lagging and fiscal support lacking strength – a coalition partner pulled out of Italy’s governing coalition, depriving the government of its majority. As the Dutch government resigned, we have lowered our growth forecast for the Eurozone and predict the bulk of the rebound to come later in the year, with carry-over effects into next year. We now predict growth of 3.4% in 2021 (down from 5.2% previously) and 4.9% in 2022.
United Kingdom
A "two minutes to midnight" Brexit deal and an impressive start to the UK’s Covid vaccination programme have both supported economic prospects over 2021. But the surge in daily coronavirus cases, driven by the increased transmissibility of the so-called "Kent variant", has led to a third national lockdown and is set to result in a sharp fall in GDP in Q1. Accordingly, we have downgraded our GDP forecast to 6.2% from 7.0% for this year, although we expect the economy to continue to grow robustly next year, by 5.3%. Helped by a likely diminution of the Covid threat, plus a softer US dollar generally, our baseline case is for cable to rise to $1.40 by the end of this year and to $1.53 by end-2022.
Global
Signs of strengthening in global growth are evident in a number of areas. For example, the recovery in global trade has been gathering pace: the latest October figures showed a 1.6% y/y fall, up from -14% in June. If anything, more timely data from heavyweight Asian exporters such as China, S.Korea and Indonesia have pointed to further recovery, December export growth ranging from +4 to 17% (3m yoy). However, a shortage of freight containers emerged as an unexpected impediment to global trade. This was most notable on the China-EU shipping route and consequently pushed up the price of a container from $2k (Oct) to $12k. Leaving shipping containers in the wrong places is one hangover from the pandemic, but we believe this will subside over time.
United States
Hard on the heels of a $900bn stimulus deal passed late last year, Biden has lost little time outlining his own fiscal agenda. Proposals include spending amounting to $1.9trn and are shown (alongside those from December) in Chart 9. Senior Democrats hint that the plan is to pass this quickly before his "Build Back Better" programme (investment in infrastructure and "green" technology) is put together. The tight numbers in Congress could make this tricky and will require bi-partisanship, something in short supply in recent years. Hence, it could be halved to $1trn. But Democrats seem determined to force through material fiscal stimulus, with new Treasury Secretary Janet Yellen insisting on the need to "act big."
Priority number one for Biden will be tackling the pandemic. As Chart 11 reminds us, the spread of the virus has varied in different states. Cases rose late last year, leading to higher hospitalisation rates and greater fatalities (though daily infections have since come down). University of Washington estimates point to more than 566k deaths by May 1. Restrictions vary from state to state. As can be seen in North Dakota, cases have fallen sharply from Nov-20 as a result of compulsory mask-wearing. Biden is keen to hit the ground running and plans to vaccinate 100 million people in 100 days. His new executive order includes mask wearing for interstate travel.
Eurozone
Whilst Covid developments will certainly be a driver of short-term macro-dynamics, in the medium term, prospects will in part be supported by fiscal stimulus stemming from the EU’s €750bn NextGenerationEU package. Crucial to this will be the early deployment of funds (this year), which in turn depends on national governments submitting their Recovery and Resilience Plans (RRP) by April, which will ultimately determine the disbursement of funds. To date, the European Commission has taken a less than enthusiastic view of some of the plans submitted so far. Nonetheless, given the funds on offer, we suspect this will be addressed, providing stimulus, which we believe will support annual growth of 3.4% in 2021 and 4.9% in 2022.
However, domestic political issues could potentially hamper the distribution of EU funds. In Italy, differences of opinion on spending plans almost caused the government to collapse in January when Matteo Renzi withdrew his party, Italia Viva, from the coalition. It survived a confidence vote, albeit with a loss of its majority in the Senate, undermining its ability to pursue its policy objectives. Political issues at the start of 2021 have been evident elsewhere too, with the Dutch government resigning over a child benefits scandal. It will continue to act in a caretaker capacity until March, but this too could disrupt spending plans. Indeed, political risks will be a feature of 2021 given the now fragile nature of Italy’s government, elections in the Netherlands as well as later in the year in Germany.
Eurozone inflation has held steady at -0.3% yoy for four months. Energy prices have exerted a key pull lower; excluding them, inflation would have been +½%. Germany’s temporary VAT cuts since July also weighed on inflation. Had they been passed on in full, this may have depressed inflation by 0.4-0.5pp; in practice, the impact was probably less. Still, base effects from both these factors clearly point to sharp temporary rises in Eurozone inflation in H1 2021. But the “underlying” rate of inflation is somewhere between ½% and 1%, and thus clearly depressed by spare capacity; without government support, importantly also for labour markets, it would be lower still.
The ECB upped its stimulus measures in December to counter the disinflationary impulse of the pandemic, boosting the Pandemic Emergency Purchase Programme by €500bn to €1.85trn and extending liquidity operations that allow banks to borrow on favourable terms. As the economy has since developed broadly in line with its expectations – which importantly had assumed tight Covid restrictions throughout Q1 and only very gradual rollout of vaccines – no further measures were announced this month. The focus is on keeping financial conditions, in terms of lending rates, credit conditions and yields, favourable for households, firms and governments.
Eurozone inflation has held steady at -0.3% yoy for four months. Energy prices have exerted a key pull lower; excluding them, inflation would have been +½%. Germany’s temporary VAT cuts since July also weighed on inflation. Had they been passed on in full, this may have depressed inflation by 0.4-0.5pp; in practice, the impact was probably less. Still, base effects from both these factors clearly point to sharp temporary rises in Eurozone inflation in H1 2021. But the “underlying” rate of inflation is somewhere between ½% and 1%, and thus clearly depressed by spare capacity; without government support, importantly also for labour markets, it would be lower still.
The euro has climbed in two steps last year, first from mid-February to early March and again through July. Since then, it has remained broadly steady, strengthening against the USD but weakening against the Yuan and GBP, which constitute its three largest trading partners. We expect most of these trends to persist, as the dollar loses more of its safe-haven allure in a post-pandemic recovery, and sterling, with the Brexit hurdle negotiated, moves towards closer towards long-term PPP estimates of “fair value”. In light of the shortfall of inflation vis-à-vis target, the ECB is likely to continue monitoring the currency closely.
United Kingdom
The UK vaccine rollout is well underway. All four nations have taken the same "top-down" approach - vaccinating those who are clinically vulnerable, frontline NHS staff and the elderly first. As new variants of Covid-19 are discovered, speed is everything. Whilst progress will differ across regions, the narrative remains on track that all adults will be offered the vaccine by the autumn. Overall, the pace of the UK rollout has been brisk. But UK governments will be wary about removing restrictions too soon. As such, we see Q1-21 GDP of 2.5% with a rebound in Q2-21 to 6.9%, pending any further restrictions.
Social restrictions have supported spending on goods at the expense of services. Indeed in Q3, the annual growth of retail sales stood at +2.9%, while household consumption (which also includes services) was down 10.1%. Helped by government support, household incomes since the pandemic have remained close to Q1 2020 levels, while lower consumption pushed the saving ratio to record highs of 27.4% in Q2 and 16.9% in Q3. In turn, the stock of household bank deposits has accelerated (Chart 21). We estimate that such "excess savings" totalled £76bn in November, and if all of it were spent over 2021, this would add some 6% to consumer spending.
More likely is that it addresses short-term downside risks by stepping up the pace of its weekly QE purchases from the £4.4bn prevailing through much of H2 last year (the current rate of buying is clouded by the replacement of a large redemption). On fiscal policy, we still suspect Chancellor Sunak will signal limited tax hikes at the 3 March Budget, because he needs to show he is addressing the UK’s poor fiscal metrics. December’s data showed the cumulative deficit for 2020/21 so far to be £271bn, implying borrowing of some £340bn this year, below many estimates. But note that several pandemic schemes (e.g. CBILS) are not yet properly recorded in the data, which may give rise to upward revisions.
"Lockdown 3" is set to result in a contraction in the economy in Q1 and a delay in the UK’s recovery. Our GDP growth forecast for 2021 is now 6.2% from 7.6% previously. But we now see the rebound in activity following through into next year, clawing back a further 5.2% in 2022. Christmas Eve’s trade deal saw a muted reaction from the pound, with the expectation of a deal already priced in. That said, the possibility of negative rates continues to cap the currency. As vaccines are rolled out and confidence begins to spring back further into the year, we see the pound making up significant ground, with cable reaching $1.40 by end year and surpassing the $1.50 level in H2 next year.
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