The U.K. economy has contracted sharply since the beginning of the pandemic, with April’s 20.4% fall in gross domestic product the steepest monthly decline on record. Meanwhile, borrowing surged to £103.7 billion ($128.9 billion) in the April-May period, meaning public sector debt surpassed GDP for the first time since 1963.
However, central to the country’s ability to weather the economic storm so far has been the furlough scheme, which has supported more than 30% of the nation’s jobs and meant that the steep drop in output has not filtered through to the labor market as yet. The program has been credited with preventing the country’s looming recession from morphing into a deep and prolonged depression.
Impending ‘jobs crisis’:
Sunak has previously indicated that the furlough scheme is likely to be tapered from August and end in October, but Credit Suisse has projected that this could result in unemployment rising from 3.9% to 10%, or 3.5 million people, in the second half of the year.
In a note, Monday, the bank’s economists suggested it was unlikely that the 9.3 million furloughed workers would be reabsorbed into the jobs market, with the end of furlough bringing about another wave of redundancies.
“This is because, beyond the near-term pickup, we think there is a risk that the recovery slows down as consumer caution due to the persistence of the virus and social distancing restrict domestic demand and Brexit risks weigh on sentiment,” the note said.
Credit Suisse urged Sunak to either extend the furlough scheme beyond October or replace it with a scheme that subsidizes wage costs or cuts National Insurance contributions for the sectors likely to be the hardest hit, like retail, travel, and hospitality.
Mike Bell, a global market strategist at JPMorgan Asset Management, told reporters at a virtual roundtable Tuesday that the British economy was “propped up in a state of suspended animation” by the furlough scheme. He warned that many of the currently furloughed workers would end up unemployed once the scheme is lifted as many sectors struggle to recover.
“Ending the furlough scheme in October is like building a bridge that goes three-quarters of the way across a river,” Bell said. He stressed that the signals of economic recovery in the U.K. do not account for the potential fall in consumer spending and economic activity, should furloughed jobs end up being lost.
Potential policy moves:
Temporary National Insurance cuts are among the potential policy initiatives floated in advance of Sunak’s speech, along with the subsidies for businesses hiring trainees. Other possible announcements include a temporary cut to VAT (currently at 20%) and temporary exemptions to business property taxes.
“Rather than stimulating a housing market recovery, it would delay it by incentivizing people to wait until the tax cut before buying a house,” he said, arguing that any policies announced Wednesday should be rolled out as soon as possible.
“The risks of a policy mistake are asymmetric – with greater costs associated with doing too little rather than too much,” he added.
Berenberg estimates that U.K. output is currently around 15% below its pre-recession peak, given data points like May’s 10% rebound in retail sales and more optimistic survey data. But it does not expect GDP to return to the level seen in the fourth quarter of 2019 until early 2023.
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