Further increases in prices may lead to slower economic growth as consumers’ purchasing power erodes.
The return to lockdown provides another hit to economic activity as we begin 2021. Yet, despite the near-term gloom, there are some reasons to be more optimistic about the outlook for the rest of the year.
These chiefly relate to the vaccine rollout and the tantalising possibility that this lockdown could be the last of the pandemic.
This Insight looks at the state of the economy heading into 2021, how badly the current lockdown may hit economic activity and the prospects for growth over the rest of the year.
Autumn virus resurgence halted recovery
The economy entered 2021 on a weak footing. As Covid-19 case numbers increased in the autumn, a second lockdown was introduced in England in November. Similar measures were also introduced in the other nations of the UK around this time.
This led to GDP falling by 2.6% in November, ending six months of growth from the depth of the spring 2020 lockdown. Overall, GDP was 9% lower in November than it had been in February, before the pandemic’s full impact on the UK economy was felt.
The same sectors that were the worst affected by the initial wave of the pandemic were hit again. The arts, entertainment and hospitality sectors were among the worst affected.
December figures, not available until mid-February, may show some improvement due to the (brief) ending of the lockdown. However, it is fair to say 2020 ended with a whimper.
Impact of early 2021 lockdown
Driven by a new variant of the virus, infection rates rose sharply during December. Lockdowns were again introduced across the UK by early January 2021 in order to reduce the spread of the virus.
These early 2021 lockdowns are stricter than the November ones, notably with schools shut for most children. As a result, the economy is expected to see a downturn in economic activity. The Chancellor has said he expects the economy, “to get worse before it gets better”.
During the first wave of the virus, GDP fell by a total of 25% in March and April 2020 combined. Economists do not expect anything like such a large fall in GDP from the early 2021 lockdown. There are two reasons to assume a less severe economic impact:
- The restrictions are not as severe (more is open) and some parts of the economy were more likely to stay open this time, such as manufacturing and construction.
- People and businesses are better prepared for working and shopping from home.
At this early stage, traditional economic data is not yet available to show the impact of the early 2021 lockdown. However, other measures appear to support the view that economic activity will have fallen by more than in the November lockdown but not as much as the spring 2020 one.
For example, people seem to be making fewer journeys so far in January than they did in November. The chart below is based on data from Apple, but data from others such Google and the Department for Transport present similar trends.
A survey of economists conducted by the Treasury in January, showed the average forecast was for GDP to fall by 2.9% in the first quarter of 2021 compared with the last quarter of 2020.
Some reasons for optimism
On a more positive note, the relatively quick rollout of the vaccines suggests brighter prospects ahead at some point in 2021. The faster the most vulnerable are protected against Covid-19, the faster (at least some) restrictions can be lifted.
Some believe the economy will bounce back quickly once most restrictions are lifted. For instance, the Bank of England Governor said he thinks a “pronounced recovery” was likely, while the Bank’s chief economist was even more ebullient talking of recovery “at a rate of knots from the second quarter”.
The case for greater optimism rests largely on the chances of a speedy recovery in consumer spending, the largest contributor to economic growth. Households have, in aggregate across the whole economy, saved more than normal during the pandemic. A reduction in how much is saved once the lockdown comes to an end would lead to more spending, boosting growth.
In addition, consumer and business confidence may improve with the expectation that we could soon have more certainty about when the pandemic will end.
Nevertheless, not all economists are sold on a speedy recovery. Households may choose to hold more precautionary savings than they did before the pandemic, potentially stifling a rapid rebound in spending.
And while government schemes have prevented mass unemployment so far, the outlook for the labour market in 2021 remains uncertain. Unemployment may rise following the closure of these schemes (the furlough scheme is scheduled to run until the end of April) and some businesses may struggle to repay loans they have taken on.
As has been the case for much of the past year, it will be developments in tackling the spread of Covid-19 that will be most important in determining the country’s economic prospects.
Coronavirus: Economic impact, House of Commons Library
Economic Indicators, House of Commons Library
About the author: Daniel Harari is a researcher specialising in UK and international economies at the House of Commons Library.
Economic growth is slowing and the end of the furlough scheme, along with rising inflation, means uncertainty ahead.
Official employment and unemployment figures show the UK is in a strong position, but furlough scheme is due to end in September.