The Bank of England has forecast that the coronavirus crisis will push the UK economy into a historically large recession, with output dropping 30 per cent in the first half of the year, but it decided not to launch a new stimulus.
In its monetary policy report, the central bank presented rough and ready predictions for the economy, suggesting that output would dip 3 per cent in the first quarter followed by a further 25 per cent fall in the second. This would mean a 30 per cent drop overall in the first half of 2020, the fastest and deepest recession in more than a century.
In a warning to Britain’s banks, the BoE said the contraction would be even deeper and bank losses even greater if they refused to lend to companies, forcing them into bankruptcy.
The BoE said the UK’s unemployment rate was likely to rise to 9 per cent, even with the government’s job retention scheme protecting many employees from being laid off. That would mean a higher rate of joblessness than after the 2008-09 financial crisis.
The central bank also forecast that inflation would dip to 0.5 per cent in 2021, before returning to the 2 per cent target the following year.
The BoE examined spending figures from a large survey of bank accounts to inform its view that there had been “a reduction in the level of household consumption of around 30 per cent”.
In the financial stability section of its report, the central bank warned that if high street lenders failed to provide credit to their business customers, they might see a short-term benefit in reduced losses, but would cause more companies to fail and unemployment to rise another 2 percentage points, ultimately leading to larger losses.
Urging banks to keep lending, Andrew Bailey, BoE governor, said: “By supporting households and business, banks will help to avoid a worse outcome for the economy as a whole, which would in turn generate greater credit losses and weaken their capital positions.”
The governor tried to present an upbeat view of UK prospects, saying that the economy was likely to bounce back “much more rapidly than the pull back from the global financial crisis”.
He added that because he expected the government’s support schemes to be successful, there would be “only limited scarring to the economy”. The BoE back-of-the-envelope scenarios assumed the only long-term damage would come from missed business investment in 2020.
“The UK economy and financial system are robust to a period of social distancing that extends through the summer and is phased out by September and to a number of sensitivities either side of that,” Mr Bailey added.
The BoE said it stood ready to put more money into the economy should it be needed and had further meetings planned for June — before the £200bn it pledged in March to support economic activity by buying government bonds was likely to run dry.
Not all Monetary Policy Committee members supported the majority decision. Two of the nine members, Jonathan Haskel and Michael Saunders, voted to increase quantitative easing by another £100bn immediately.
All members of the MPC agreed that more stimulus might be needed in future. In the minutes, the committee said: “For all members of this group, the prospective weakness in employment and inflation, and downside risks around aspects of the medium-term outlook, might necessitate further monetary policy action”.
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The BoE also undertook an exercise to test whether the financial system could cope with the expected once-in-a-century recession and concluded that it could.
It assessed that banks would lose less money than in its latest stress test and “the core banking system has capital buffers more than sufficient to absorb losses”.
It did, however, stress the pandemic would severely hit corporate cash flow. It said that while UK companies normally operate with a cash flow deficit of £80bn, the crisis would raise that to £190bn. Government support would plug some of the gap, but there remained a £60bn additional deficit that banks would need to cover to stop viable businesses from going under.