2021: Overcoming the Health and Economic Crisis
What lies ahead for the UK economy in 2021? A year ago, it was remarkable how often the forecasts for 2020 contained puns about perfect 2020 vision. We avoided them, and just as well. In the event few, if any, saw what lay ahead. It was a year when a downside tail-risk dominated as the pandemic hit. This triggered dramatic movements in financial markets and huge proactive policy stimulus measures, particularly across the so-called advanced economies.
How one views the outlook for the year-ahead will, naturally, be influenced heavily by how one sees the pandemic playing out.
The last twelve months have witnessed a global health crisis that triggered a global economic crisis, and it is only once the health crisis is overcome that the economic crisis can be addressed.
The challenges ahead
Since the virus hit, the combination of testing, track and trace, plus how behaviours changed relative to before the pandemic, have had an important influence on outcomes and the extent to which different countries have been able to both adapt and mitigate its full impact. Such influences look set to remain important, particularly in coming months, including in the UK where lockdowns and restrictions will impede the economy.
But the big influence in 2021 will be on the effectiveness and roll-out of vaccines. Their expected success will be vital as it should be the trigger for a significant turnaround in the UK economy from the spring, onwards. If not, then economies will have to adapt, which I am sure they can, but in a different way.
At the time of writing a new variant of the virus has been found in the UK and some other countries, but the expectation that this does not have more severe outcomes nor is expected to impact the efficacy of the virus has allowed the markets to appear relaxed. However, it does suggest the tight restrictions will impact the UK economy through the first quarter.
On the economic side, a number of features are likely to dominate in 2021.
One is the legacy of this pandemic. There will be scarring with a further increase in unemployment and also with many small firms nursing high levels of debt.
However, as we have seen since May, it has been a two speed UK economy. After collapsing by around a quarter in March and April, the economy then turned the corner. While some firms and sectors were hit hard – particularly tourism, hospitality and the creative industries – others have performed far more strongly and there has been a surge in personal savings as many people have been unable to spend.
Thus, on the upside in 2021, there is the expectation of a rebound in personal spending and corporate investment as the vaccine allows a reversal of restrictions and a return to normality.
This holds out the possibility of a strong economic rebound but it is hard to quantify this.
Higher growth, and perhaps, higher inflation expectations
The Treasury’s December analysis of latest private sector forecasts showed an expected fall of 10.9% in 2020 followed by a rise of 5.4% in 2021. Certainly, a strong rebound is likely during 2021, the exact timing and scale, though, is hard to say. Prior to the latest lockdown and news of a new variant of the virus I would have been forecasting a rebound of closer to, or even above 8%. Now, with a further lockdown, somewhere around 6% to 8% may be a better guide.
On this basis it would not be until the first half of 2022 that the economy returns to pre-crisis levels. But the second half of 2021 could prove very strong indeed. Much also depends upon developments elsewhere, and the extent to which there may be a synchronised global turnaround.
Inflation, too, is another uncertainty in 2021. Some of the annual rates of inflation could spike higher, because of events in 2020, but even allowing for this, overall inflation pressures should be subdued. But market inflation expectations, which are low, could rise, heavily influenced by events in the US.
Globalisation, technology, financialisation and a squeeze on the share of wages in national incomes have all contributed to a low inflation environment over recent years. But, some reversal of these features, plus the scale of policy stimulus that has materialised, may trigger a rise in inflation expectations.
The impact of policy
The outlook for policy will be another key impact. Central banks have behaved in a similar way across advanced economies, with low policy rates, expanded balanced balance sheets and buying of government debt. While exit strategies may vary – China for instance talks of a proactive fiscal and prudent monetary policy in 2021 – across western economies, monetary policy is expected to remain accommodative.
Fiscal policy, meanwhile, has carried out more of the heavy policy lifting globally during this crisis and on a far greater scale than following the 2008 financial crisis. During 2021 a key aspect of the UK policy debate will be the future path for fiscal policy. Ideally, premature tightening will be avoided and there will be a likely focus on reducing the ratio of debt to GDP, gradually, over time.
Also, 2021 will see the UK host the G7 and the major COP26 climate agenda meeting. A focus on addressing climate change and moving towards a net carbon zero economy will thus be an increasingly important area.
Finally, Brexit will unfold. We will return to this in the new year, once the terms of exit are clear. This is already having a significant influence on sterling, which remains at a very competitive level.
It is premature to say what will change as a result of this pandemic. I have suggested, previously, that there will be a renewed focus on grassroots, green and geopolitics. Meanwhile, some of the dominant pre-pandemic trends will continue to prevail, including the fourth industrial and digital and data revolution, and the increasing growth from the Indo Pacific region (from India in the west to the US in the east). This points to a change in the future of work and the need for a global focus.
The UK economy remains significantly imbalanced and with low productivity. Before this crisis, the talk was of levelling up and of boosting productivity. Now, to these, will be added how to bring the public finances back into shape. The Government has made clear there will be a reset of policy. What that means for economic policy remains to be seen. There is a need, though, for a pro-growth policy.
Overall, the focus in 2021 will be on how the U.K. like other western economies overcomes the health crisis and then sees a strong rebound. This will be helped by continued accommodative policy, with no premature tightening in fiscal policy and continued low interest rates.
Please note, the value of your investments can go down as well as up.