Pandemic set to permanently scar the economy

The deficit is here to stay for years to come as Covid costs and a smaller economy hit the Chancellor’s finances, the OBR forecasts

Britain’s second wave of Covid “took the wind out of the recovery” and the pandemic may now leave a permanent scar on the economy and the national finances, the Government’s official forecaster has warned.

GDP is expected to fall by 11.3pc this year, the biggest collapse in more than 300 years.

The economy is not expected to claw back that lost output until late 2022, the Office for Budget Responsibility (OBR) said, and even by the end of 2025 GDP is expected to be 3pc smaller than it would have been without the pandemic.

This is equivalent to £1,400 for every adult in the UK, according to the Resolution Foundation.

Unemployment is set to hit 7.5pc by the middle of next year, falling only slowly so it is still at 4.4pc in 2026, compared to 3.8pc at the end of 2019.

Meanwhile the Government is borrowing hand over fist, racking up a deficit of £394bn this year, £164bn next year and £100bn or more in each subsequent year forecast by the OBR.

This will take the national debt up to £2.8 trillion by 2025-26, peaking relative to the economy at almost 110pc of GDP in 2023-34.

Richard Hughes, chairman of the Office for Budget Responsibility, said the second wave of Covid “took the wind out of the recovery”, with England’s second lockdown plus restrictions in other regions likely to bring GDP down by around 15pc compared with pre-pandemic levels.

This is not as severe as the first lockdown, as businesses have learned how to cope with the rules and schools are still open. Mr Hughes said the extension of the furlough scheme and other support is likely to have protected around 300,000 jobs, but still represents an enormous challenge to the economy.

But the sustained economic harm will be felt by the economy for years because of the long-term effects of lower business investment and higher joblessness.

Rishi Sunak, the Chancellor, acknowledged the severity of the crisis: “Our health emergency is not yet over, and our economic emergency has only just begun,” he said as he presented his spending review, ramping up spending without mention of extra taxes.

The speed and extent of the recovery depend heavily on progress in the fight against the vaccine. The OBR’s central forecasts anticipate restrictions remaining in place until the spring with widespread vaccinations only in the second half of 2021.

Mr Hughes said: “While we’ve had encouraging news about several vaccine trials in recent days, there remains considerable uncertainty about how effective those vaccines will prove to be in preventing not only infection but also transmission of the virus – and about how quickly they can be rolled out to the general population.”

If the second wave is defeated and an effective vaccine can be rolled out more rapidly, the OBR said GDP could fully recover by the end of next year and even make up all of the lost ground in the coming years.

In such an “upside scenario”, debt could be brought back under control and fall to 90pc of GDP in the coming years, while unemployment would barely rise above 5pc before falling back down.

But if the virus is not soon controlled and the vaccine does not work rapidly, resulting in a third wave or more, then the OBR foresees a “downside scenario”. In this dire forecast the economy remains permanently 6pc below its pre-Covid path, unemployment surges as high as 11pc, and the national debt hits 120pc of GDP - and stays there.

A “no deal” Brexit could worsen any of these scenarios, knocking 2pc off GDP and adding £10bn to annual borrowing, the OBR predicted.

In any instance, economists doubt that the Chancellor will be able to call an end to his spending binge after the £335bn in Covid cost this year and next.

“The idea that there will be no permanent increase in spending post-pandemic is what you might politely call optimistic,” said Torsten Bell at the Resolution Foundation.

“It is certain that tax rises will end up playing a bigger part in any real plan to put the public finances on a sustainable footing once the recovery is secured.”  

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