The UK economy faces a 35 per cent plunge in output in the second quarter of 2020 if a lockdown to fight the spread of coronavirus remains in place for three months, the country’s fiscal watchdog has warned.
The Office for Budget Responsibility said on Tuesday that in this scenario, government borrowing would rise by £218bn to £273bn in 2020-21, taking the deficit to 14 per cent of gross domestic product — the highest since the second world war and well above the financial crisis peak of 10 per cent.
The downgrade to the OBR’s March forecast was largely due to a collapse in tax revenues, which would be 15 per cent, or £130bn, lower than the watchdog expected a month ago. Government spending would be £88bn higher than forecast in March — largely due to the measures taken to support household incomes — and at 52 per cent of GDP, also the highest since 1945.
The OBR emphasised that these measures should help to limit the long-term damage to living standards and the public finances, stressing that “the costs of inaction would certainly have been higher”.
“It’s clear this will have a very significant impact on our economy . . . It’s important to be honest about that,” chancellor Rishi Sunak said in response to the OBR’s report. “It’s clear that we must defeat this virus as quickly as possible. That’s not a choice between health and economics.”
The OBR said the figures should be taken as a “reference scenario”, not a forecast of what was most likely to happen, because it could not predict how long restrictions on economic activity would last.
To calculate the hit to GDP, it estimated the share of output that would be lost in each industry, factoring in the share of key workers and those able to work from home: hardest hit are education, with output down 90 per cent, and accommodation and food services, down 85 per cent.
Its estimate of the quarter-on-quarter fall in GDP is on a similar scale to the economic hit predicted by official statisticians in France, where comparable lockdown measures are in place. The OBR said it would be accompanied by a very fast rise in the unemployment rate, which could reach 10 per cent in little more than a month, despite extensive use of the government’s furlough scheme.
It has assumed that about 30 per cent of UK employees would be covered by the furlough scheme, at a cost to the exchequer of £42bn — far higher than the Treasury’s original estimate. Equivalent support for self-employed workers could cost the government about £10bn over three months.
The OBR has assumed that the three-month lockdown would be followed by a further three months of partial restrictions, after which the economy would recover quickly with no lasting damage.
“We hope the contraction is temporary. In this modelling we have not tried to estimate any longer-term scarring to the economy,” said Robert Chote, the OBR’s chair.
Paul Johnson, director of the Institute for Fiscal Studies, a think-tank, said: “Let’s hope they are right to be as optimistic as they are about the speed of recovery once lockdown is over.”
Even on these relatively benign assumptions, GDP would still fall by 13 per cent on an annual basis in 2020 — much more than the annual falls seen around the ends of each world war or in the financial crisis, the OBR said.
Public sector net debt would rise sharply to exceed 100 per cent of GDP in the short term, reflecting not only higher government borrowing, but also the Bank of England’s additional quantitative easing and its new cheap financing for banks. Debt would end the fiscal year at 95 per cent of GDP — compared with the 77 per cent the OBR had forecast just over a month ago. It would remain 10 per cent of GDP above the Budget forecast even in 2024-25.
The OBR said each additional month of lockdown could add about £35bn to £45bn to borrowing in this fiscal year, with a somewhat smaller amount saved for each month less.
The Resolution Foundation, a think-tank, said the OBR’s scenario, while grim, was far from the worst case — because it assumed “almost no scarring or lasting impact on the economy from this recession, which history shows is unlikely to be the case”.