Bank of England offers hope amid Covid-19’s grim economic spectacle | Larry Elliott | Business

Bank of England offers hope amid Covid-19’s grim economic spectacle | Larry Elliott | Business

It’s hard to be all that cheerful when you are bracing yourself for the biggest annual contraction in the economy since before the South Sea Bubble crisis of 1720, but somehow or other the Bank of England has managed to find some nuggets of hope amid all the gloom.

To be sure, the short-term news from Threadneedle Street was as grim as everybody had expected. Having fallen by 3% in the first three months of 2020, activity is projected to drop by a further 25% in the second quarter and by 14% over the calendar year.

Yet the Bank is assuming that lockdown restrictions start to be lifted from the start of next month and that the economy then starts to recover, that it expands by 15% in 2021 and by the end of next year is almost back to where it would have been had the pandemic never happened.

Just how realistic this proves to be remains to be seen. In the aftermath of the global financial crisis in 2008-09, the Bank consistently over-estimated the pace at which the economy would bounce back and productivity would recover.

This time it thinks things are different. One of the problems during the financial crisis was that the damage caused to the banking system impeded the flow of credit to firms and reduced productivity-enhancing investment. Today, the banks are in far better shape to help businesses through short-term cashflow problems caused by the lockdown.

Indeed, one of the key messages from the Bank to the high-street lenders was that they stand to lose more by not lending than they will by lending freely, because there will be more long-term scarring of the economy, more companies going bust and more losses for them to swallow. At his press conference, the Bank’s governor, Andrew Bailey, said he was ramming home this point to lenders at every opportunity.

One of the two main definitions of recession in the UK is at least two quarters of negative economic growth. Judged by this yardstick, the UK was last in recession in 2008-09, when there were six consecutive quarters of negative growth. 

Some economists believe this definition of recession is flawed, since an economy would not be in recession if it contracted by 5% in the first quarter, expanded by 0.1% in each of the following two quarters and then contracted again by 5% in the fourth quarter. It would, however, be deemed to be in recession if it grew by 5% in each of the first and fourth quarters but contracted by 0.1% in each of the second and third quarters.

An alternative – and tougher definition – is a full calendar year of negative output. Given the UK economy has grown on average by 2.5% over many decades, it is rare for gross domestic product (GDP) to fall on an annual basis. There have been only five such years since the end of the second world war: 1974, 1975, 1980, 1981 and 1991.

The United States has its own method of assessing recession, with the National Bureau of Economic Research’s business cycle-dating committee making a judgment.

The NBER defines recession as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production and wholesale-retail sales”.

That said, the Bank is still working on the assumption that there is a V-shaped pattern to the economy, albeit with the downward part of the V taking six months and the upward part taking 18 months. Some voluntary physical distancing will continue even after formal government curbs have been removed, it suspects.

The Bank was at pains to point out that it has produced an illustrative scenario rather than a forecast, and that’s a reasonable point. Forecasting is tough at the best of times: in the current circumstances – where there is uncertainty about how fast restrictions will be lifted, how consumers will behave, and whether there will be a second wave of infection – it is all but impossible.

All that can really be said is that the risks to the Bank’s scenario are skewed heavily to the downside. Threadneedle Street decided against providing more stimulus at this week’s meeting, but it is only a question of time.

In the event that the pandemic does return, Bailey said the Bank would find new tools from somewhere. That might sound a bit like Mr Micawber saying “something will turn up”, but it broadly sums up current thinking: this is bad, but somehow or other we will get through it.

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