STRONG VACCINE TAKEUP AND FISCAL STIMULUS BOOSTS RECOVERY HOPES

1. The Bank of England expects the economy to recover faster in 2021 than previously forecast according to the latest Monetary Policy Report. The lockdown over Q1 was previously expected to result in a 4.25% fall in GDP in the period, but this has been revised upwards to a fall of just 1.5%. This suggests that the economy was somewhat more prepared to operate under lockdown measures, and so the outcome was less severe than in the lockdowns in 2020.
    
2. Extended fiscal support announced in the March Budget, primarily the extension to the furlough scheme, together with a relatively successful vaccination programme has boosted the prospect of a faster recover in the remainder of the year. The latest forecasts from the Bank see unemployment rising to a peak of around 5.5% in 2021 Q3. This has been revised down significantly from over 7% in previous forecasts. The extension of the furlough scheme is the key reason for this revision, as economic activity is expected to return to pre-Covid levels around the same time the scheme ends. Other fiscal support such the capital allowance super‑deduction is expected to boost business investment, reversing much weaker levels of investment over the past year.
    
3. It would also appear that there is greater optimism from consumers, presumably buoyed by the vaccine rollout. On the back of a recent survey the Bank estimates that households are now willing to spend around 10% of the additional savings they have accumulated over the pandemic period, up from 5% based on a previous survey. GDP is now expected to grow by 7.5% in 2021, compared to the 5% forecast back in February.
    
4. Looking past 2021, demand is expected to slow as the bounceback effects fade. Furthermore, the announced tightening of fiscal policy in the form of increased corporation tax and freezing of personal tax thresholds acts as a drag on the economy. GDP growth is now expected to be 5.75% in 2022, compared to 7.25% forecast in February. CPI inflation is expected to reach 2.5% by the end of the year due to changes in energy prices, strong growth in demand relative to supply as the economy reopens. However, supply is expected to recover so that it is broadly balanced with demand by the end of 2022.
    
5. Whilst the economic outlook has significantly improved, the risks are certainly skewed to the downside, with so much uncertainty remaining in regards to the health, societal, and economic impact of covid-19 virus. As an open economy, the UK recovery is also heavily dependent on a successful global vaccination programme, which is yet to play out. Interest rate expectations have risen since February reflecting this improved outlook, and the likelihood of further monetary policy stimulus, such as negative rates, has perhaps reduced somewhat, but cannot be ruled out given the level of uncertainty that persists around covid-19.
    
6. The Monetary Policy Committee voted to maintain the Bank Rate at 0.1% in May, however one member of the committee, Andy Haldane, somewhat surprisingly voted to reduce the target stock of government bond purchases to £825 billion from £875 billion. This reflected the inflationary risk posed by stronger than expected demand that is likely to persist past 2021, supported by evidence that households were now willing to spend more of their accumulated savings that previously thought. 
    

BUILDING SOCIETIES SEE PROFITABILITY FALL IN 2020

7. Net interest margins (NIM) in the building society sector fell for the fifth consecutive year in 2020. This reflects a reduction in net interest income as a result of the fall in Bank Rate to 0.1%. Adding to this, some societies opted to maintain savings rates whilst the Bank Rate was falling in order to support savers, and other invested heavily in technology, putting further pressure on profitability. Other sources of income also fell across the sector. Meanwhile, in response to the economic downturn due to coronavirus, many societies increased provisions for future credit losses. You can find the full report, plus the Annual Accounts interactive tool on the BSA website (login required).
    
8. Kroll Bond Rating Agency (KBRA) recently published a report that explains how UK building societies remain resilient despite the Covid and Brexit related development weighing on the economy. Despite the reduction in NIM, and the vulnerability of building societies to rising unemployment, a downturn in the housing market and reduced asset quality, these are mitigated by having sound capitalisation, ample liquidity, and stable funding.

You can download the full market update here which includes analysis of the mortgage and savings markets.