The economy started the year on a strong note, but it is only a matter of time before it succumbs to the effects of the coronavirus. To reflect the weaker global backdrop and the likelihood that measures implemented to limit the spread of the virus will dampen business activity and spending by households, we have revised down our GDP growth forecast for this year from 1.0% to 0.7%. We also now expect the Bank of England to cut interest rates from 0.75% to 0.50% soon and the Chancellor to announce in the Budget on 11th March an extra package of measures to help support businesses and households. At the moment, we envisage that a 0.2% q/q rise in GDP in Q1 will give way to a stagnation in Q2 before the economy gets back on track in the second half of the year. But the clear risk is that the hit to GDP will be bigger or last longer, thereby requiring a larger policy response.
- The economy started the year on a strong note, but it is only a matter of time before it succumbs to the effects of the coronavirus. To reflect the weaker global backdrop and the likelihood that measures implemented to limit the spread of the virus will dampen business activity and spending by households, we have revised down our GDP growth forecast for this year from 1.0% to 0.7%. (See Chart 1.) We also now expect the Bank of England to cut interest rates from 0.75% to 0.50% soon and the Chancellor to announce in the Budget on 11th March an extra package of measures to help support businesses and households. At the moment, we envisage that a 0.2% q/q rise in GDP in Q1 will give way to a stagnation in Q2 before the economy gets back on track in the second half of the year. But the clear risk is that the hit to GDP will be bigger or last longer, thereby requiring a larger policy response.
- Output & activity indicators reveal that it taking longer for firms to source components or products.
- Household indicators suggest that discretionary spending is most exposed to coronavirus concerns.
- External indicators indicate that UK export and import volumes will fall sharply in Q2.
- Labour market indicators suggest that the virus could lead to at least some postponing of hiring activity and falls in weekly hours worked.
- Inflation indicators are likely to show that the virus will temporarily reduce inflation rather than raise it.
- Financial market indicators show that the FTSE 100 has fallen by 13% since 17th January and 10-year gilt yields have fallen to a record low of 0.33%.
Chart 1: GDP (%y/y)
Sources: IHS Markit, Capital Economics
- The rebound in economic activity in Q1 is likely to be short-lived due to the impact of coronavirus and measures taken to reduce its spread. Based on the assumption that, like in other countries, coronavirus cases rise from 90 now to thousands (2), we have revised down our 2020 GDP growth forecast from 1.0% at the start of the year to 0.7% (3).
- February’s activity PMIs are now pointing to GDP growth of around 0.3% q/q in Q1 2020, up from 0.0% in Q4 2019 (4). However, the impact of coronavirus on the economy is likely to start to weigh on activity in March and into Q2. Indeed, the manufacturing PMI was boosted by a slump in the suppliers’ delivery times balance, which usually indicates strong demand but in this case is because of disruptions to supply chains caused by the coronavirus outbreak in Asia (5).
- Admittedly, there will probably be additional stimulus in the Budget on March 11th to combat the impact of the virus on top of the already large stimulus we have been expecting (6). But we estimate that the global and domestic impact of the virus will reduce UK GDP growth this year by 0.3 percentage points, with most of the effect being felt in the second quarter when GDP may not rise at all or may even fall (7).
Chart 2: Coronavirus Cases (Number)
Chart 3: GDP (% y/y)
Chart 4: Activity PMI & GDP
Chart 5: Manufacturing Suppliers’ Delivery Times (Bal.)
Chart 6: Fiscal Impulse (Change in Cyclically Adjustment Budget Deficit, % of GDP)
Chart 7: GDP
Sources: Refinitiv, IHS Markit, OBR, Capital Economics
- A solid start to the year for consumer spending will probably be undermined by consumers’ concerns about coronavirus. But the hit to consumer spending from the virus will be temporary.
- The large 1.6% m/m increase in retail sales was a tentative sign that the pick up in consumer sentiment since the election had started to feed through to higher consumer spending (8). What’s more, the 10% fall in equities over the last fortnight is unlikely to be much of an impediment to consumer sentiment (9). And the recent rise in housing market activity and prices may offset any negative wealth effect from lower equity prices (10).
- So far, timely retail sales data and cinema ticket sales show no adverse impact from coronavirus concerns (11). But we suspect consumers will soon start to rein in their discretionary spending. We think that a 0.5% q/q rise in consumer spending in Q1 will be followed by a stagnation in Q2 (12). But as has been the case in past epidemics, most of any income saved over that period will probably eventually be spent, so consumer spending growth will probably rebound later in the year (13).
Chart 8: Retail Sales Ex. Fuel
Chart 9: Equity Prices & Consumer Confidence
Chart 10: Mortgage Approvals & House Prices
Chart 11: Cinema Ticket Sales (£m per weekend)
Chart 12: Household Spending
Chart 13: Household Spending (% y/y)
Sources: Refinitiv, GfK, Nationwide, BoE, IMDb, Capital Economics
- The coronavirus-related disruption will significantly distort the trade figures in the coming quarters. Export volumes rose by 9.3% m/m in December before the coronavirus outbreak, outpacing the 0.5% m/m increase in imports. That resulted in the trade in goods and services surplus growing from £1.8bn to £7.7bn. (14). But the sharp rise in export volumes had more to do with the sharp rise in the volatile non-monetary gold component than anything else (15). Excluding this, net trade was a drag on GDP growth in Q4 2019 (16).
- And the downgrade to our 2020 global growth forecast, from 2.9% pre-coronavirus to 2.0%, suggests that the annual growth rate of UK export volumes will fall from +4% in Q4 2019 to around -2% in early 2020 (17).
- Imports may be significantly hit too. Indeed, there will be knock-on effects from the ongoing disruption in China, which is the third largest supplier of intermediate products to the UK (18). And February’s IHS Markit/CIPS manufacturing survey showed that the suppliers’ delivery times balance lengthened significantly, posting the biggest month-on-month move since the survey began in 1992 (19).
Chart 14: Trade in Goods & Services Balance (£bn)
Chart 15: Non-Monetary Gold Volumes (£m)
Chart 16: Net Trade (Contribution to q/q GDP Growth, ppts)
Chart 17: World Goods Trade & UK Goods Exports (Volume, % y/y)
Chart 18: UK Intermediate Imports, 2015 (% of Total)
Chart 19: Manufacturing Suppliers’ Delivery Times
Sources: Refinitiv, Capital Economics, TiVA
- The coronavirus outbreak will probably result in weekly hours worked growth falling further (20) and lead to at least some postponing of hiring activity in the coming quarters.
- Admittedly, employment rose by 180,000 in the three months to December and surveys of firms’ hiring intentions suggest that employment growth will remain close to 1% (21 & 22). The increase in the number of job vacancies to 810,000 in the three months to December from 803,000 in November is also consistent with the unemployment rate remaining close to its current 45-year low of 3.8%. But the coronavirus might lead to at least some postponing of hiring activity and falls in employment in the coming quarters (23).
- There is a good chance that pay growth slows further too. Headline annual pay growth has already slipped from 3.2% in November to 2.9% in December, its slowest rate since August 2018. And January’s REC Report on Jobs suggests that it could drop to just over 2.0% (24). Meanwhile, the 6.2% y/y rise in the National Living Wage will probably only provide a small boost of 0.1ppts to earnings growth in April (25).
Chart 20: Employment & Total Weekly Hours Worked (% y/y)
Chart 21: Employment
Chart 22: Employment PMI & Employment
Chart 23: Real GDP & Employment
Chart 24: REC Permanent Salaries Index & Pay
Chart 25: National Living Wage (% y/y)
Sources: Refinitiv, IHS Markit, REC, BoE, Capital Economics
- We are not expecting the effects of the coronavirus on the economy to result in a spike in inflation. If anything, the fall in the oil price and the dampening effect on demand means that over the next year inflation may be a bit further below 2.0%.
- The plunge in the oil price to US$50 per barrel at the end of February suggests that fuel prices fell by about 2% m/m in February and will probably fall by the same again in March (26). That would take 0.2 percentage points (ppts) off January’s CPI inflation rate of 1.8%. There’s no evidence that disruptions to crops or transport are pushing global agricultural prices higher (27), although it’s possible that shortages of some components or goods could result in higher prices for cars and electronics in the coming months.
- But such effects may be offset by lower airfares due to the plunge in international travel, any easing in wage costs due to a softer labour market (28) and April’s scheduled cut in the Ofgem utility price cap. The latter will take 0.3 ppts off inflation (29). As such, we expect both CPI and core inflation to stay below 2% this year, before a rebound in oil prices contributes to CPI inflation rising closer to 2% next year (30 & 31).
Chart 26: Oil & Fuel Prices
Chart 27: Global Agricultural Commodity Price Index
Chart 28: Average Earnings & CPI Core Services Inflation
Chart 29: Contribution of Utilities to CPI Inflation (ppts)
Chart 30: Oil Price & Fuel Price Contribution to Inflation
Chart 31: CPI Inflation (%)
Sources: Refinitiv, BEIS, Capital Economics
Financial Market Indicators
- UK equities, bond yields and interest rate expectations have all plummeted in the wake of the jump in the number of coronavirus cases in the UK and Europe. However, looking through the short-term impact of the virus, UK equities should outperform other equity markets over the next few years.
- UK equities followed global markets off a cliff at the end of February (32). Although they have recovered a little on the back of the 50bps Fed rate cut, they are still down 13% since 17th January. Unsurprisingly, the worst affected sectors have mainly been consumer focused ones, such as automobiles and travel companies (33). The markets are expecting the Bank of England to cut interest rates by 50bps in the coming quarters (34). All this has pulled down 10-year Treasury yields to below 1.0% for the first time and 10-year gilt yields to just 0.33% (35). Meanwhile, sterling has fallen by 2.8% against the US dollar and 2.3% against the euro since the start of the year (36).
- However, looking past the short-term impact of the coronavirus, and assuming a disruptive Brexit at the end of 2020 is avoided, we think that UK stocks will outperform other developed market indices (37).
Chart 32: Global Equity Indices (Jan. 2019 = 100)
Chart 33: Worst 10 Performing FTSE All Share Sector Sectors Since 1st February (% Change)
Chart 34: Market Interest Rate Expectations (%)
Chart 35: 10-Year Government Bond Yields (%)
Chart 36: Exchange Rates
Chart 37: Equity Indices
Sources: Bloomberg, Refinitiv, Capital Economics
Paul Dales, Chief UK Economist, +44 20 7808 4992, email@example.com
Ruth Gregory, Senior UK Economist, +44 20 7811 3913, firstname.lastname@example.org
Thomas Pugh, UK Economist, +44 20 7808 4693, email@example.com
Andrew Wishart, UK Economist, +44 20 7808 4062, firstname.lastname@example.org
James Yeatman, Research Economist, +44 20 7808 4694, email@example.com