Bank of England's V-shaped scenario differs from the Fed's view

The Bank of England's Monetary Policy Report for May shows an economic "scenario" that depicts the "worst UK recession for 300 years". This sounds extremely alarming, and indeed it is. But in fact the MPC has probably chosen the least-bad path for output that is feasible in present circumstances. As many independent economists have warned, a completely unbiased central projection would have been considerably worse, especially after the trough of the recession is reached.


The Bank’s projection assumes a decline of 3 per cent in the level of real GDP in 2020 Q1, followed by a further decline of 25 per cent in 2020 Q2. This collapse in output is the inevitable result of lockdowns in the supply side of the economy, and is largely replicated by the Bank's assumptions about global GDP. The result, in the Bank's view, will be the deepest UK recession that has been seen since the "Great Frost" in 1709.

Bank of England Monetary Policy Report, May 2020

However, that is where the Bank’s pessimism ends. The real issue for the UK economy and markets is not the depth of the decline in output in the current quarter, since the effects of the recession on household incomes and business finances will be automatically cushioned by the huge fiscal and credit schemes that have been announce by the UK authorities. As a result of these schemes, UK unemployment is expected to rise to "only" 9 per cent in Q2, about half the rate expected in the US.

What will matter more in the end is how rapidly the economy recovers to pre-crisis levels of output, as and when the lockdowns end. On this, the Bank expects a fairly rapid recovery, certainly more rapid than the upswing that followed the Great Financial Crash in 2008/09. As a result, the level of UK GDP returns to its pre-crisis level in mid 2021. The recession is expected to be painful but brief, as Governor Bailey emphasised yesterday.

Llewellyn Consulting, led by former OECD Chief Economist John Llewellyn and former market economist Russell Jones, point out that this type of sharp recovery is not the typical pattern after a very deep recession. In most previous examples, it has taken many years to attain pre-crisis levels of output, not just a single year.

With thanks to Llewellyn Consulting

The Bank of England clearly recognises these issues, but has decided not to talk too much about them for now. Furthermore, the MPC was willing to take the risk of disappointing the markets by leaving monetary policy unchanged in its May meeting.

For whatever reason - and it is quite hard to fathom - the Bank's attitude differs quite markedly from the recent guidance from the US Federal Reserve on these matters.

Among many other FOMC members, Chairman Jerome Powell said last week that a prolonged recession could occur if the US government fails to expand its direct help, in the form of grants, to American businesses, in order to prevent even greater losses of jobs and permanent damage to the labour market. He seems to be much more pessimistic about the speed of recovery from the virus, and therefore more aggressive on his language about monetary policy support for the economy, than is the case with Andrew Bailey at present.

Only time will tell who is right, but my guess is that Mr Powell's caution about the pace of recovery from the COVID-19 crisis will stand the test of time.