Test & Trace Splurge Helps Rescue UK Economy in December, GDP Records Worst Annual Dip in History

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The UK economy suffered its sharpest annual decline on record in 2020 the ONS has confirmed, but a pickup in spending to fight the covid-19 health emergency means the country is set to avoid a double-dip recession.

The UK was on target to avoid another recession thanks to a stronger-than-expected boost to economic activity with the ONS reporting on Friday that GDP grew 1.2% in December.

This means December's GDP is 6.3% below the levels seen in February 2020 which compares with 7.4% below pre-pandemic levels in November 2020. Annual GDP fell by 9.9% in 2020, the largest yearly fall on record.

The UK economy grew 1.0% in the final quarter of 2020, which double the 0.50% growth the market was expecting.

With the UK economy in a strict lockdown in the first part of 2021 the quarter will likely result in negative growth.

But the positive growth in the final quarter of 2020 means that the technical definition of a recession - two successive quarters of decline - will be avoided.

Above: GDP grew by 1.2% in December 2020 after falling by 2.3% in November. Monthly index, January 2007 until December 2020, 2018 = 100. Source: Office for National Statistics - GDP monthly estimate.

"This means a technical double-dip recession will probably now be avoided. And even though the third COVID-19 lockdown means that the economy will almost certainly take another step down in January, GDP should rebound sharply in the second half of 2021," says Thomas Pugh, UK Economist at Capital Economics.

UK GDP was -7.8% lower in the year to the end of December, which is slightly less than the -8.1% economists were expecting.

According to the ONS, the services sector acted as the main contribution to growth in December, increasing by 1.7% as a number of consuming facing industries reopened following the easing of restrictions in December.

Interestingly, the ONS reports that the government's gargantuan spending spree on its covid Test & Trace programme actually boosted economic activity.

The government said the cost of the Test and Trace system would rise to £22BN after announcing in November an additional £7BN would be made available to the programme.

Data shows that health contributed a sizeable upward impulse to the economy, "with the strongest contributions coming from the coronavirus testing and tracing schemes," says the ONS.

"Big upward revision to UK health output in the monthly GDP figs as test and trace is accounted for. A key factor in the circa 1-1.5% upgrade in the level of monthly GDP through the back-end of 2020 vs. previous estimates," says James Smith, Economist at ING.

But, the UK economy has been put back in the deep freeze in January warns the ONS.

Results from the ONS' Wave 23 of the Business Impact of Coronavirus (COVID-19) Survey (BICS), which covered the dates 11 to 24 January 2021, found that 12% of currently trading UK businesses said that turnover had decreased by more than 50% compared with what is normally expected for this time in January.

"Getting the pandemic under control is critical to our recovery, and speedy rollout of vaccines gives us some hope. But until this ends the stop-start cycle of lockdowns, businesses will need support to continue in parallel with restrictions," says Alpesh Paleja, Lead Economist at the CBI.

The percentage of businesses currently trading fell to 71% in January (Wave 22), after falling from 84% of businesses currently trading in mid-December 2020 (Wave 20) before the current lockdown restrictions began.

Other data released by the ONS confirms the significant challenges facing the economy going forward.

Business Investment fell 10.3% year-on-year in the final quarter of 2020, while UK Construction Output fell 3.7% year-on-year in December.

Manufacturing production fell 2.5% year-on-year, and industrial production was down 3.3% in the same period.

"The third lockdown and the closure of schools will take the level of GDP a bit lower in January than in December when it was 6.3% below its pre-crisis level. But the rapid vaccine rollout means that COVID-19 restrictions should be eased from the spring," says Pugh.

Foreign exchange markets have largely ignored the GDP data, suggesting the numbers were expected.

Instead they are forward looking in nature and the Pound has been bid higher over recent weeks as investors look forward to an easing of lockdown in coming weeks as vaccines start to make an impact on the pandemic.

"We think that household consumption will go from being the weakest sector of the economy to the strongest, as spending in pubs, restaurants and hotels surges, funded by the large stock of savings built up during lockdowns," says Pugh.

Capital Economics maintain an above consensus forecast that the economy will return to its pre-pandemic size in the first quarter of 2022, implying the Bank of England won’t need to loosen policy further and that the government won’t need to tighten fiscal policy.