"A Very Sharp Contraction" - Economists React to Lockdown 2.0

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The UK government looks set to secure parliament's support for a new one-month lockdown in England, due to start on November 05.

In a Commons statement Prime Minister Boris Johnson said there was "no alternative" to the new restrictions that would for a second time in 2020 shut down swathes of the UK economy and put thousands of jobs at risk.

Johnson said he was "right to try every possible option" before ordering people to stay at home.

Economists at ING say the new lockdown measures will take roughly 6-7% off monthly economic growth in the month of November, following a forecasted 1% contraction in October.

That figure could however rise if some schools are closed, or if there is a knock-on effect on industries not officially required to close.

For the fourth quarter as a whole, that’s likely to mean a contraction of roughly 1.5% if most restrictions are lifted in December, or 2%+ if restrictions last longer.

"This is a very sharp contraction. That said, it's clearly not as sharp a decline as we saw at the beginning of the pandemic, where during March and April we saw a 25% contraction," says James Smith, Developed Markets Economist at ING.

ING economists observe the second lockdown is not as restrictive as the first and while the ‘stay at home message’ is similar, "the manufacturing and construction sectors will remain open, as will schools," says Smith.

Analysts at independent economic research providers Oxford Macroeconomics estimate the hit to the economy for the fourth quarter as a whole will be larger than the 1.5% forecast by ING.

"We expect the second national lockdown to cause GDP to fall by 3% in Q4, but this would be a much smaller drop than that seen in the first wave. The smaller fall will be due to the lockdown being shorter and involving less stringent restrictions. The decision to keep the education sector open will be particularly important, not just in terms of its direct contribution to output but also because it will allow working parents to continue to work," says Andrew Goodwin, Chief UK Economist at Oxford Macroeconomics.

Based on the measures announced so far, Oxford Macroeconomics expect GDP to fall by 10% month on month in November, a much smaller drop than in February to April, when GDP fell by 25%.

There are two reasons why Oxford Macroeconomics think the economic impact of the second lockdown will be smaller:

1) The new lockdown is less restrictive, with several sectors that were closed last time remaining open. Of these, the education sector is particularly important.

2) Many sectors have continued to operate well below pre-pandemic levels, and the lower base leaves less scope for output to fall as sharply this time.

The Pound started the new week sharply lower against the Euro, Dollar and other currencies as markets reacted to the developments, which were first leaked in after-hours trade on Friday night.

"It’s increasingly clear that the UK is one of the bigger losers from the pandemic in terms of growth expectations. Average growth forecasts for 2020/2021 have fallen by 2.3% and 1.9% in the Eurozone and US respectively since the start of the year, but they are down by 2% in the UK," says Kit Juckes, an analyst at Société Générale.

Although there was an initial hit to the Poundy and UK-focussed assets, losses were soon overturned as the impact of a second lockdown was gauged to be less severe and amidst signs the government will revert back to a regional whack-a-mole approach from December 02 onwards.

"Despite some initial selling of risk assets such as equities following the news of lockdowns across Europe, financial markets remain orderly and calm. The current mood is very different from the first wave of European lockdowns in Spring when the BoE and ECB had to take aggressive emergency measures to prevent a credit crunch and financial crisis," says Kallum Pickering, Senior Economist at Berenberg.

"The return to 'partial' lockdowns will trigger another quarter of economic contraction in Q4 for both the euro-zone and UK economies although it is expected to be milder than the unprecedented plunge recorded earlier this year," says Lee Hardman, Currency Analyst at MUFG.