The UK economic crisis caused by Covid-19 will be less severe than expected, but the recovery will also take longer, the Bank of England has said.
The faster easing of foreclosure measures and a “faster” recovery in consumer spending allowed the economy to rebound earlier than it had expected in May.
Spending on clothing and household items has returned to pre-Covid levels.
However, the BoE warned of a “significant” rise in unemployment this year, as it kept interest rates at 0.1%.
Governor Andrew Bailey said recent data suggested the recovery in consumer spending was gaining ground, while spending on food and energy bills remained above pre-Covid levels.
He said: “We have seen a strong recovery in the last few months. The pace puts the economy ahead of what we expected in May. ”
However, Bailey cautioned against overreading recent data: “We don’t think the recent past is necessarily a good guide for the immediate future,” he said.
The Bank said spending on leisure and entertainment, which accounts for one-fifth of all consumer spending, has remained subdued.
Business investment was also weak, which would weigh on the recovery.
The Bank expects the UK economy to shrink 9.5% this year.
While this is the biggest annual decline in 100 years, it is not as steep as his initial estimate of a 14% contraction.
The Bank said the UK was still facing its deepest recession on record, with growth prospects now “unusually uncertain”.
He expects the UK economy to grow 9% in 2021 and 3.5% in 2022, and the economy is expected to return to its pre-Covid size by the end of 2021.
This compares to growth estimates of 15% and 3% respectively, in a scenario the Bank presented in May.
Unemployment is expected to almost double from the current rate of 3.9% to 7.5% by the end of the year, as government-funded support schemes end.
Average profits are also expected to decline for the first time since the financial crisis.
The bank said more workers were facing a pay cut or freeze in 2020, adding: “In many cases bonuses have been reduced or completely removed for this year.”
Its latest forecast is based on the assumption that there is no second wave of the virus and that there is a smooth transition to a new EU free trade agreement in early 2021.
Lower energy prices and the temporary reduction in VAT for hotels, theme parks and other hotel activities mean the cost of living is unlikely to increase much this year.
The Bank expects inflation, as measured by the Consumer Price Index (CPI), to fall close to zero by the end of 2020, before gradually rising to its 2% target.
Negative rates “under review”
The Monetary Policy Committee (MPC) has said it will not even think about raising interest rates until there is “clear evidence” that the recovery has taken hold.
He said the use of unconventional tools to stimulate the economy, such as negative interest rates, remains under consideration.
While negative rates could boost the economy, the bank said such a move could have unintended consequences.
This could prevent the UK’s already fragile banks from lending or entice customers to withdraw their money and keep it in cash.
Policymakers also noted that High Street banks would find it difficult to reduce savings rates below zero.
“They are part of our toolbox,” Mr. Bailey said. “But at the moment, we don’t have a plan to use them. ”
Ruth Gregory, an economist at Capital Economics, said the bank will likely increase its money printing program by an additional £ 100 billion later this year.
She also expects the Bank to keep interest rates at 0.1% “or less” for “at least five years.”
The economic damage may have been less catastrophic than feared in recent months, but the Bank believes the scars will remain longer, for both activity and jobs.
The Bank estimates that it will take the economy until the end of 2021 to resume its pre-crisis activities. Basically, he admits the risks are on the downside – especially assuming the health risks from the virus and restrictions gradually diminish, without a significant resumption of a widespread lockdown. It could be a serious setback.
So what? The key to our recovery is consumer spending – and the potential interest rates that are already at historically low levels. Could we be heading into the uncharted territory of negative rates, where savers are effectively tasked with depositing cash? It seems unlikely. The Bank has taken a closer look at this tool and concludes that it may be “less effective… in stimulating the economy”.
It has other tools – the Bank has supported cash flow throughout the economy by injecting funds into financial markets through quantitative easing and by participating in some loan programs.
But she may have to rely increasingly on the Chancellor to provide emergency aid to the economy in the event of further unrest.