The UK economy and the road ahead

01 May 2020

Phil Shaw

Investec Chief Economist

The Covid-19 pandemic has tipped us all into a state of collective, global uncertainty. We have seen an astonishing shift since the beginning of the year and the world is in crisis.

Now, despite indications that we may be moving past the peak of the pandemic and towards a gradual lifting of lockdown measures, we still face a great many questions when it comes to the economy - now and in the future.

In recent client conversations with entrepreneurs and business owners, there is a clear hunger for information. My colleagues and I are hearing questions all the time about the shape of the economy in the coming months - both in the UK and in key overseas markets - as well as a desire for insight around where there may be opportunities to grow and innovate.
 
In a webinar, hosted by myself and my colleague Deborah Sayagh, we aimed to tackle some of those questions, and for those of you who weren’t able to join us on the webinar, I wanted to share some of our thoughts and analysis here. If you have time, at the bottom is a recording of the full webinar.
 

I’ll start with a brief look at the current situation.

In the UK, we have now spent just over five weeks under lockdown, and data from the Department for Transport on vehicle usage suggests that - by and large - we have done a good job of observing the restrictions set out by the government. Road traffic volumes on 27th April were 56% lower than recorded during the first week of February - a strong indicator that people are staying at home as requested. Moreover, the good news is the measures are working. Data from the NHS suggests that, over the past week, the number of people admitted to hospital with Covid-19 has dropped by 16%, indicating that we have passed the peak in infection and are on the downward turn. This is also what Prime Minister Boris Johnson announced during a recent media briefing.
 
Now, of course, the Government faces a difficult decision regarding what happens next. Already it is facing an enormous amount of pressure from businesses who are lobbying for an easing of restrictions, with the cabinet itself said to be divided over the matter. Some countries on Continental Europe, where infections also appear to have peaked, are now edging towards a gradual lifting - although Angela Merkel has urged caution, warning of a possible second peak. This is a prospect many leaders are wary of given the evidence of past pandemics where there were resurgences due to lockdown restrictions being eased too quickly.
 
Saying this, it’s fair to assume tentative steps will soon be taken to reopen economies.
 
With the caveat that we do not have a crystal ball on these matters, let’s consider what we know so far, and what we estimate might come next with regards to the slightly longer-term outlook.
 
Firstly, it’s important to note that this economic crisis is not a rerun of the 1930s, nor indeed the Global Financial Crisis. That our current banking system is in relatively good shape is, naturally, a reason to be relatively optimistic: we are not faced with attempting to put the system back together again. Banks can - and should - be part of the solution through this crisis.
 
That’s not to say, however, that we should be relaxed. We, at Investec, certainly are not.
 
We are in a downturn. Anecdotally, we are beginning to get more evidence on the depth of that downturn. We are also beginning to get figures around the GDP figures of other nations - though not for the UK yet. We believe that the UK’s first quarter is likely to look better than our European neighbours due to the fact that we entered lockdown quite late. The second quarter will be another story. It is going to reflect the epicentre of the economic crisis and see some ludicrous falls.
 
Early estimates for the UK suggest that we should expect to see a quarter-on-quarter contraction in GDP by 27% in the second quarter (by way of comparison, in 2008 we saw a shrinking of just 6% over an 18-month period). This will be coupled with a sharp rise in unemployment rates, and sadly - despite the many Government measures, which I shall come on to shortly - many business failures.
 
Fortunately, fears of a protracted U-shaped recovery are unrealistically pessimistic; we are unlikely to bump along the bottom for a protracted period of time.
 
We forecast a slightly more optimistic ‘lopsided V.’ This would suggest a relatively quick recovery triggered by a spike in consumer demand as lockdown lifts and specific sectors begin to reopen. We are predicting a 31% bounceback quarter-on-quarter in the third quarter, although recovery will not be as steep as its corresponding decline.
 
Our full year forecast for GDP, meanwhile, indicates a contraction of 8.9% in 2020, with a predicted rebound of 8.4% in the following year. It is worth bearing in mind that the figures for the bounce back are from a lower base, so it’s not like with like.
 
Internationally, the picture is very similar: economic scarring of some form will almost certainly apply to most developed economies. The global economy is forecast to shrink almost 4% this year, although again the transitory nature of the crisis is such that a bounceback of 6.5% in 2021 is anticipated.
 
The UK Government, as we know, was quick to put together a package of measures to address the various aspects of this crisis, which recognised the extent to which the economy is being hit. Thanks to the highly-targeted approach from Mr Sunak - who is enduring a baptism of fire in his first months on the job - and an impressive degree of coordination between the Government and the Bank of England, these measures will go some way to mitigating the impact of this crisis. Realistically, however, there is only so much they can do.
 
It has been suggested that a direct cost of £75 billion will be incurred as a result of these measures, with fiscal watchdog OBR anticipating the deficit to rise to £275bn this year. Eye-watering figures, yes - but cheaper than allowing our economy to crumble.
 

Where does all this leave us?

Until 7th May - ‘crunch date’ as far as making a decision on the UK’s lockdown restrictions is concerned - we can only speculate.
 
Evidently there is a huge economic case to be made for beginning to ease the lockdown, although in doing so we must be aware that moving too suddenly could result in a second wave, the impact of which could be catastrophic for the economy (not least for the human lives associated) if not contained.
 
But, at the same time, current measures are smothering business output - and whilst the battery of policies and schemes put together by the Government are doing their best to mitigate the impact on businesses and ensure that the damage done to our economy is permanent - the question remains: is it enough?
 
The good news is that in many ways we are seeing the positive impact of easing certain regulations as well as schemes like the Covid-19 Job Retention Scheme and Business Interruption Loan Scheme. Together, these measures are creating space for businesses to keep themselves and their cash flow going. Moreover, we are hearing more examples of industry bodies and entrepreneurs being able to pivot, adapt, and grow; I had a conversation with a client who had retooled production lines to manufacture PPE visors - a positive example for businesses.
 
Hopefully, when all this is over, the Government will look at what businesses have been able to achieve during this crisis and recognise that when things need to be done quickly and efficiently, you need to have the right business environment in order to foster a resilient economy.

Q&A

A snapshot of some of the questions - and answers - received during the webinar:
 
Could you speak a little more regarding the inflation versus deflation debate, and which route you think will be followed?
Already, we’ve seen examples of higher inflation in shops - but though we may see food inflation rising, overall the rate of inflation in both the short and medium-term is likely to fall. This is, on balance, a disinflationary event. We suspect inflation will remain low for a while, which will encourage central banks to keep interest rates lower for longer.
 
What are your views on the impact of Covid-19 on the commercial and residential property markets in the short and medium term?
This is a difficult question to answer. As there are so few transactions taking place currently, it is difficult to measure prices, and I caution against putting too much trust in price indexes where transactions are so low, and thus the sample sizes so small.
 
In the residential market, it seems likely we might get a sudden surge in transactions once restrictions are lifted, so after a few months we may well see a bounceback and resumption in price growth.
 
On the commercial side, it is trickier to say, although with bricks and mortar retailing struggling prior to the pandemic, that struggle will intensify, if anything. One area of likely growth may be warehousing, with firms looking to hold larger inventories of goods in the future.
 
What is your view on what will happen to the UK employment market beyond this period?
This depends on how quickly restrictions are able to be unwound. Over three million UK workers have already been furloughed, and the risk is that these workers get taken off the furlough scheme and made unemployed.
 
The outlook, sadly, is that the unemployment rate will increase and perhaps quite significantly.
 
Prior to the crisis the UK unemployment rate was estimated at a record low of 3.8%. However, with furlough schemes possibly ending in September (if not earlier in June), this could see unemployment grow sharply. Saying that, we didn’t reach the “worst case scenario” of 10% after 2008, and hopefully won’t following this crisis, either.
 
What do you think will be the global impact if the situation in American worsens?
With the USA, there’s a general assumption that if things get worse there will be a knock on effect around the world. There’s also little sign that lockdown measures across the states should be lifted. Whilst political spokespeople claim that US fatalities may have peaked, the data does not yet show a convincing-enough fall for this to be a confident assumption.
 
A number of states have begun removing some of their lockdown restrictions, which may stimulate the economy. The danger of course is that this will trigger a second upsurge in fatalities, as was seen in San Francisco and St Louis in 1918. That said, many areas in America remain under reasonably strict lockdown, so on the whole America’s economic pain looks set to last a while longer.
 
From a political standpoint, it’s unlikely we will see a postponement to the presidential elections - which would be unheard of - but it is clear that Trump is under significant pressure to reopen the economy because of the looming elections.
 
What impact will this have on Brexit negotiations?
Although Brexit negotiations may not be making headlines at the moment, they are still happening behind the scenes. Prior to the pandemic what we thought would happen was for the Government to maintain a hard line with the EU, and to avoid extending the transition period. Now, we have an 11-month transition period until the end of 2020 and with it the option to extend negotiations - although the Government maintains it does not want to do this.
 
Covid-19 may change things, of course. The impact of the pandemic has been to delay negotiations, weaken every economy across Europe, and to divert the attention of governments towards negating the repercussions of the crisis.