The Bank's predictions of a strong rebound after the crisis depend on a number of deeply uncertain suppositions
When the Bank of England is warning of the biggest hit to the economy in 300 years, it seems strange to call it optimistic. Unemployment of 9pc and a 25pc output slump in the current quarter, detailed in the latest Monetary Policy Report, hardly seem like material for the sunny-side-up brigade.
But the Bank’s “illustrative scenario” – which due to the uncertainty of the Covid-19 outbreak is necessarily more vague than its usual forecasts – has the UK economy bounding rapidly back in 2021 to reclaim its lost ground, when some independent forecasts say that could take as long as five years.
Yes, the economy may shrink 14pc this year, but, according to the Bank, it will recover 15pc next year and that ugly-looking spike in unemployment will be back down to 4pc in 2022.
Why so cheery? Governor Andrew Bailey suggests that the main factor is the massive scale of the Government and monetary response, driven by the furlough scheme paying the wages of millions of workers.
Bailey, who must have had the busiest two months of any new central banker anywhere, says the evidence so far suggests “it will smooth companies and the economy into action”.
In Threadneedle Street’s worldview, although some voluntary social distancing remains after the lockdown, the economic scarring from Covid-19 is minimal. That view isn’t unanimous however, as demonstrated by the call of two Monetary Policy Committee rate-setters for an extra £100bn in quantitative easing.
Jonathan Haskel and Michael Saunders argued that “without further monetary stimulus, there could be greater scarring effects on the economy via both demand and supply channels”.
Huge amounts depend on the assumptions made. The Bank has pencilled in a steady winding down of social distancing and Government support measures by the end of September, and does not take any account of a second wave of infection: this a significant risk as the UK comes out of lockdown, potentially triggering the reimposition of restrictions.
Bailey admitted the Bank “would have to respond” to that if the virus rears up again. As a guide, Threadneedle Street reckons that every fortnight of lockdown in the UK and around the world knocks 1.25 percentage points off GDP. Even if we escape, there’s the threat of outbreaks overseas denting supply chains here.
Other hostages to fortune are also acknowledged. If households increase precautionary savings as a result of the virus for fear of job losses, that will drag down consumer spending and hence growth as demand suffers.
On the supply side, the report also flags the risk of a larger hit to productivity than its main scenario if uncertainty about the outlook persists and makes firms less willing to invest. The Bank sees business investment tumbling 26pc this year, but will it necessarily get the 19pc recovery it is after in 2021?
The Bank’s Financial Stability Report also points out that companies have a £140bn cash hole thanks to the virus so if they are forced to lay off staff or sell equipment, productivity makes a further blow.
The BoE has also made a critical assumption that unemployment eventually falls back to close to its pre‑Covid level without a rise in the “equilibrium rate”: the level of joblessness that the UK can sustain without fuelling inflation.
If companies are reluctant to hire until they are sure about the strength of the recovery, that key rate could drift higher as more workers become detached from the labour force. Don’t forget the hundreds of thousands of school and university leavers without a foothold in the jobs market and facing a very uncertain future as well.
Then there’s Brexit. As is customary, the Bank’s assumptions follow Government policy, which is for a comprehensive free trade agreement by the end of the year. Given the current state of talks, how likely is that?
In a worst-case scenario the UK could be dealing with a second wave of infection and an end to our European Union transition with no trade deal in place. It’s time to cross everything and hope that Bailey’s coronavirus optimism isn't misplaced.