Perspectives

Another contraction in Q4, before a definitive recovery?

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Eco Perspectives // 1 quarter 2021  
economic-research.bnpparibas.com  
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UNITED KINGDOM  
ANOTHER CONTRACTION IN Q4, BEFORE THE DEFINITIVE RECOVERY?  
The record fall in UK GDP in the second quarter gave way to unprecedented growth in the third, and the news that an  
effective vaccine against Covid-19 will soon be widely available suggests that the economy could start its definitive  
recovery in 2021. However, the UK is not out of the woods yet. Given that a second national lockdown was introduced  
in England in November, there is little doubt that economic activity will drop again in the fourth quarter. Moreover,  
the strength of the recovery is, because of Brexit, more uncertain than elsewhere. This not only because of the UK’s  
decision to leave the EU’s single market and customs union, but also due to continued uncertainty over whether a  
free-trade agreement will be found.  
According to the initial estimate from the Office for National Statistics  
(
ONS), the UK’s GDP bounced back in the third quarter, growing by  
GROWTH AND INFLATION (%)  
1
5.5%. This strong rebound, which followed a fall of 22% in the first half,  
was driven by the reopening of the economy after the first lockdown –  
bars and restaurants, for instance, had to wait until early July before  
reopening their doors.  
GDP Growth  
Inflation  
Forecast  
Forecast  
6.8  
6.4  
7
2
2.1  
1
.5  
1.8  
1.5  
THE ECONOMY HAS FALLEN A LONG WAY BEHIND  
0.9  
Despite this record growth in Q3, UK GDP was still nearly 10% lower  
than it was at the end of 2019. Although Spain is in a similar position,  
in the USA, France, Germany and Italy, GDP has recovered to “only”  
-3  
5
% below its level back then (see chart 2). One of the explanations for  
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this gap is the significant collapse in household consumption. While it  
has fallen by around 2% in France and 3% in the USA, in the UK it is  
down more than 12% in real terms since the end of 2019. In its latest  
Economic Outlook, published in December, the OECD forecasts that the  
fall in private consumption will be twice as deep in the UK as it will be  
in France or the Euro Zone as a whole.  
-
13  
-11.5  
2020  
2019  
2021  
2022  
2019  
2020  
2021  
2022  
CHART 1  
SOURCE: EUROPEAN COMMISSION, BNPPARIBAS  
In addition, the recovery has shown signs of running out of steam since  
the end of the summer. Monthly figures from the ONS showed that  
GDP grew by only 1.1% in September. On top of this, a fresh drop in  
GDP looks highly likely in the final quarter of 2020. This is because  
the government responded to a deterioration in the health situation  
by introducing a national lockdown across England from 5 November  
to 2 December. After this ended, England returned to a tiered system  
of restrictions that is stricter than the one that was introduced in  
October. In the highest tier (“Very High”), household mixing is forbidden  
indoors and only allowed in outdoor public spaces for groups of six  
people maximum; in addition, bars, restaurants and hotels are not  
closed, except for sales by takeaway, click-and-collect, drive-through  
or delivery services.  
REAL GDP (Q4 2019 = 100)  
1
05  
00  
1
9
9
8
8
7
5
0
5
0
5
United Kingdom  
United States  
Germany  
France  
Italy  
That said, the adverse economic impact of this second lockdown will  
surely be less severe than the first. One reason is that it was shorter  
and less restrictive. Another is that the starting point for the economy  
was much lower than it was in the first quarter. As a result, BNP Paribas  
expects that GDP will fall by ‘only’ 3.7% in the final quarter.  
Spain  
Q1 2019 Q2 2019 Q3 2019 Q4 2019 Q1 2020 Q2 2020 Q3 2020  
CHART 2  
SOURCE: ONS, OECD  
In addition, fears of a sharp rise in unemployment at the end of the  
year have dissipated somewhat. Admittedly, those businesses forced  
to reduce, or indeed stop, their activity are certainly facing increased  
difficulties. However, the government has also chosen to reintroduce  
its Coronavirus Job Retention furlough scheme (CJRS) until March  
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0% by the end of the year. Since the announcement of the extension,  
the OBR has revised its forecasts, and now expects unemployment to  
peak at 7.5% in the second quarter of 2021.  
WHAT NEXT FOR MONETARY AND FISCAL POLICIES?  
021. This programme has already proved its worth. Although the  
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unemployment rate has increased since the beginning of the crisis, the  
rise has been limited to less than a percentage point. In October the  
unemployment rate was 4.8%. The CJRS had been due to end in October,  
to be replaced by a less generous scheme. This led the Office for Budget  
Responsibility (OBR) to predict a rise in the unemployment rate to over  
To face the health and economic crises in 2020, the British government  
will have spent more than GBP280 billion, and the OBR forecasts that  
the government deficit will hit 19% of GDP. In his latest Spending  
Review, the Chancellor of the Exchequer, Rishi Sunak, announced that  
GBP 55 billion would be made available to public services in 2021-22.  
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What’s more, the impact of government support on public finances will  
be felt for years to come. The OBR estimates that the deficit will still be  
around GBP 100 billion, or 4% of GDP, by 2025-26. As far as growth is  
concerned, UK GDP is not expected to return to its end-2019 GDP level  
DIFFERENCE IN REAL GDP BETWEEN NO-DEAL AND DEAL SCENARIOS (%-PT)  
0.0  
1
until the fourth quarter of 2022 .  
-
0.5  
Faced with such a sharp deterioration of public finances, the govern-  
ment could respond rapidly. Indeed, there is a risk that it will react  
too quickly. While the IMF recently cautioned against tightening fiscal  
-1.0  
-1.5  
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policy too quickly in the UK , the Chancellor has pledged to balance the  
books as soon as possible. In its central scenario, the OBR estimates  
that GBP 20-30 billion in spending cuts or tax rises would be required  
to “balance revenues and day-to-day spending and stop debt from ri-  
sing by the end of this Parliament”. Any tightening could come as early  
as in the 2021 Budget, which is due to be presented in March 2021.  
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2.0  
2.5  
3.0  
Other short run effects  
Productivty  
Capital deepening  
Border disruptions  
GDP  
Structural unemployment  
When it comes to monetary policy, the Bank of England has further  
relaxed its stance. Although it has left its policy rate at 0.10%, it has  
increased its asset purchasing programme by GBP 150 billion at the  
beginning of November. Overall, this means that its programme has  
more than doubled in size since the beginning of the crisis, to nearly  
GBP 900 billion, or some 40% of GDP.  
Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1  
2021 2022 2023 2024 2025 2026  
2020  
CHART 3  
SOURCE: OBR  
In the long term, the OBR estimates that the UK’s GDP will be 4%  
lower than it would have been without Brexit, and that a no-deal exit  
would cost an additional two percentage points. Although failure to  
reach a free trade agreement with the EU would probably harm the UK  
economy, it is in fact the UK’s exit from the single market that will have  
the biggest negative effect on growth.  
BREXIT: SO FAR, SO GOOD  
Meanwhile, the UK has concluded a free trade agreement with Canada,  
butnegotiationswiththeEUdragon. AccordingtoEuropeanCommission  
President Ursula von der Leyen, the outline of a final agreement is in  
place for most areas, but three main points of disagreement remain.  
With all that in mind, Brexit will surely have an impact on fiscal and  
monetary policy. On the fiscal side, if Brexit does have a negative  
effect on the economy – as predicted by the vast majority of studies  
on the topic – public finances will come under further pressure due  
to lower tax revenue and higher spending (unemployment benefits,  
etc.). Moreover, any benefits from stopping its contributions into the EU  
budget will be minor and will surely be offset over the next few years  
by the payment of the UK’s past commitments – the so-called “Brexit  
Financial Settlement”, which is estimated at more than GBP30 billion.  
Meanwhile, the UK might be tempted to deregulate its economy, but it  
is already one of the most lightly regulated and any relaxation would  
take the country further away from the EU, which would lead to more  
non-tariff barriers between the two parties.  
As far as monetary policy is concerned, the Bank of England may find  
itself faced with, on the one hand, a weakened economy and, on the  
other hand, strong inflationary pressures – for example caused by a  
drop in the pound and the application of tariffs on UK imports. However,  
in such circumstances, the central bank would almost certainly opt  
for a loosening of its policy, as it did when confronted with the same  
dilemma after the 2016 referendum.  
The first concerns the two parties’ commitment to respecting a “level  
playing field”, which means a framework that aims to maintain open  
and fair competition in the long term. The second has put fisheries, a  
minor industry, at the centre of the discussions. The Europeans want to  
ensure substantial access to UK territorial waters for their fishermen,  
but the UK wants to regain full sovereignty over its waters. Lastly,  
the two sides are still arguing over the governance of the agreement,  
which is to say on its dispute resolution mechanism.  
Whatever happens, the UK will leave the EU’s single market and  
customs union at the end of 2020. The country is therefore heading  
towards a “hard Brexit”, and numerous non-tariff barriers will hinder  
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its exchanges with the EU from 1 January 2021 . In the case of goods,  
these may include additional procedures, notably to meet EU standards,  
and enhanced customs controls, resulting in additional costs and more  
border delays for UK exporters.  
If no agreement is reached, these non-tariff barriers will come on  
top of tariffs imposed on goods traded between the two sides. The  
OBR estimates that a no-deal exit will trim two percentage points  
off UK growth in 2021. Given that the forecast recovery in 2021 in  
the scenario of a deal was, at 5.5%, already feeble in the light of the  
contraction in 2020, the rebound in a no-deal scenario would be very  
disappointing. This reduction in GDP growth would be due to border  
disruption, lower business investment, reduced productivity, increased  
structural unemployment, and other short-term effects on demand  
and supply, resulting in part from heightened uncertainty and tighter  
credit conditions (see chart 3). This would delay the point at which  
GDP regains its pre-virus level by almost a year (see chart 2 again).  
In summary, this saga which began more than four years ago will reach  
its final act before the end of this year. Although the effects of Brexit  
on the UK economy have so far been milder than many had feared, the  
real shock will not come until 1 January 2021, with the after-effects  
possibly to be felt for many years. What matters is not the fall, it is  
the landing.  
Completed on 7 December 2020  
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QUI SOMMES-NOUS ? Trois équipes d'économistes (économies OCDE, économies émergentes et risque pays, économie bancaire) forment la Direction des Etudes Economiques de BNP Paribas.
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