What the OBR thinks could happen to the UK economy

The economic impact of the coronavirus pandemic on the UK is likely to be significant, but recovery may be quicker than in other countries.

As the lockdown continues, more people are speculating about the cost of the crisis. Now the independent Office for Budget Responsibility (OBR) has published its latest thinking on the subject.

The OBR believes that, in addition to its impact on public health and families’ wellbeing, the coronavirus pandemic will substantially raise public sector net borrowing and debt.

This higher public borrowing and debt is primarily due to the economic disruption caused by coronavirus and the associated lockdown.

There will be direct budgetary costs associated with the government’s policy response. Still, because these are designed specifically to support individuals and businesses through the temporary shock, the measures should help prevent more significant long-term economic and fiscal damage.

There’s a high immediate cost associated with the government’s action, but the cost of inaction would have been far higher.

One of the critical assumptions underlying the OBR’s forecast is an unknown around for how long the lockdown and its economic impact will last. The government will decide when the lockdown will be lifted, backed by medical evidence.

To illustrate the potential fiscal impact of the lockdown, the OBR assumes a three-month lockdown, followed by a further three-months of partial economic restrictions. For now, they are not assuming any lasting economic damage due to this lockdown assumption.

Based on these assumptions, the size of the UK economy could fall by 35% in the second quarter. However, it should bounce back quickly.

The OBR forecasts unemployment rising by more than 2 million to reach 10% in the second quarter, and then falling, albeit more slowly than the economy recovers.

During this economic shock, policy measures would support households and companies’ finances.

They assume public sector net borrowing will increase by £218 billion in 2020/21, relative to their earlier forecast in the March Budget. This means public sector net borrowing would reach £273 billion, or 14% of GDP. Public sector net borrowing would, however, fall back to close to forecast in the medium term.

The sharp rise in borrowing this year primarily reflects the impact of economic disruption on tax receipts. There are also smaller effects from policy measures, including the business rates holiday.

Another contributor to the sharp rising in borrowing this year is the policy measures that add to public spending, but also smaller effects from rising unemployment.

Lower GDP, higher borrowing and the accounting consequences of the Bank of England’s policy measures will mean public sector net debt rises sharply in 2020/21.

Public sector net debt is now forecast to exceed 100% of GDP during the year, but this will reduce as the economy recovers.

This scenario outlined by the OBR is slightly more pessimistic than the forecast produced by economics consultancy Pantheon Macroeconomics (Pantheon). Pantheon believes the UK economy’s output is 20% below its pre-virus level during the current lockdown. However, in terms of quarter-to-quarter output figures, it says it is currently expecting a 15% drop.

However, as with the OBR, Pantheon expects a relatively sharp rebound once lockdown measures are lifted, returning to its pre-virus level earlier next year than most other countries.

Partly this is the result of the Bank of England and the Treasury both moving quickly and decisively. This was seen by the cuts in interest rates and by the Bank engaging in quantitative easing measures, which have ensured the Treasury has the fiscal space to properly respond the crisis.

Pantheon also points out the UK economy is more resilient than many other comparable economies. They point out that the economy has shown in the last decade that it can cope well with structural change, noting that the labour market is flexible and the barriers to business formation are low.

Responding to the OBR forecast, Chancellor Rishi Sunak said, “These are tough times, and there will be more to come. We came into this crisis with a fundamentally sound economy, powered by the hard work and ingenuity of the British people and British businesses.”

There’s a balance to be found between the economic damage caused by maintaining the lockdown, and the impact of lifting it too soon, as this also could be incredibly damaging to the economy.

Obviously, there’s a long way to go through this crisis, but the two forecasts above would point to there being light at the end of the tunnel.

To discuss this and/or your financial planning needs, contact Kellands today.

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