Past the nadir, but normal a long way off - Capital Economics
UK Economics

Past the nadir, but normal a long way off

UK Economics Chart Book
Written by Paul Dales

While the latest data suggest that our estimate that GDP has fallen by an eyewatering 25% from peak to trough is in the right ballpark, it looks as though the most restrictive parts of the coronavirus lockdown will be eased in May rather than in June as we had assumed. As a result, April was probably the nadir for the economy and it is likely that GDP starts to rise again in May and June. That said, it is clear that the lockdown will be eased only gradually and that social distancing measures will prevent businesses from producing as much as usual and households from spending as much for many months yet. As such, GDP may stay further below normal for even longer than we have already assumed. In other words, there’s a risk that the economic recovery looks less like our “long tick” forecast and more like a “U”.

  • While the latest data suggest that our estimate that GDP has fallen by an eyewatering 25% from peak to trough is in the right ballpark, it looks as though the most restrictive parts of the coronavirus lockdown will be eased in May rather than in June as we had assumed. As a result, April was probably the nadir for the economy and it is likely that GDP starts to rise again in May and June. That said, it is clear that the lockdown will be eased only gradually and that social distancing measures will prevent businesses from producing as much as usual and households from spending as much for many months yet. As such, GDP may stay further below normal for even longer than we have already assumed. In other words, there’s a risk that the economic recovery looks less like our “long tick” forecast and more like a “U”. (See Chart 1.)
  • Output & activity indicators such as the PMIs, which fell to record lows in April, aren’t capturing in full the extent of the decline in GDP caused by the coronavirus lockdown.
  • Household indicators, including a 99% y/y fall in private car sales, show consumption collapsed in April.
  • External indicators imply that imports have probably plunged by more than exports.
  • Labour market indicators reveal that the 6.3 million employees on the government’s furlough scheme will limit the rise in the unemployment rate, but we still suspect it will climb from 4% to almost 9%.
  • Inflation indicators suggest that CPI inflation will fall close to zero in a few months’ time.
  • Financial market indicators show that the Bank of England’s quantitative easing has helped to keep gilt yields low and has contributed to the turnaround in equity prices.

Chart 1: Level of GDP (Q4 2019 = 100)

Sources: Refintiv, Capital Economics


Output & Activity Indicators

  • Notwithstanding a slight increase in vehicle usage, which could reflect waning compliance with lockdown rules and/or some construction sites reopening, daily transport usage figures show that social distancing rules continue to supress activity (2). This was confirmed by the fall in the composite activity PMI to a record low of 13.8 in April (3).
  • While the PMI is consistent with a huge fall in GDP of over 5%, even this is likely to be an underestimate as the survey won’t account for the fact that many firms have ceased trading altogether. We suspect that GDP will fall by 25% from peak to trough. That would be a larger fall than the consensus forecast but not as severe as the OBR’s 35% decline (4). At least the spread of coronavirus now appears to be under control, so the UK may be able to follow in the footsteps of other European countries and start easing restrictions in the coming weeks (5).
  • That raises the possibility that the lockdown could be a bit shorter than the three months we have assumed, which would allow GDP to recover sooner (6). But as the restrictions will probably be eased only gradually there is also a risk that the recovery could be more drawn out and more “U-shaped” than the “long-tick” shaped recovery we envisage in our central forecast (7).

Chart 2: Transport Usage (February = 100%)

Chart 3: Composite PMI & GDP

Chart 4: GDP Forecasts (% q/q)

Chart 5: COVID-19 Deaths (7-Day Ave., T = Lockdown)

Chart 6: GDP Lockdown Scenarios (100 = 2016)

Chart 7: Level of GDP (100 = Q4 2019)

Sources: Gov.uk, Refinitiv, IHS Markit, WHO, OBR, CE


Household Indicators

  • Unlike in most recessions, we expect consumer spending to fall more sharply than GDP this time due to the direct impact of social distancing rules on sales of many consumer goods and services.
  • A sharp fall in sales of petrol and non-food goods led to the largest monthly fall in retail sales since 1996 in March, of 5.1%, which points to a similar-sized fall in overall household spending (8 & 9). Of course, with the lockdown only in place for the last week of March, we suspect sales fell much further in April, perhaps by another 30% or so.
  • Indeed, spending on major purchases has ground to a halt. There were only 871 sales of private new cars in April, down 99% from 67,873 in April 2019 (10). And rather than borrowing, consumers paid back a record £3.8bn of unsecured debt in March (11).
  • At least consumer confidence appears to have stabilised (12). But there is a risk that consumers remain cautious due to the virus after the lockdown, in which case it may take some time for footfall in shops and restaurants to recover (13).

Chart 8: Retail Sales (% m/m)

Chart 9: Retail Sales & Real Household Spending (% y/y)

Chart 10: Private Car Registrations (Seas. Adj., 000s)

Chart 11: Unsecured Household Borrowing

Chart 12: Consumer Confidence Sub-Indices

Chart 13: Footfall in City Centres (% y/y)

Sources: Refinitiv, SMMT, GfK, Springboard, Capital Economics


External Indicators

  • The plunge in global demand will weigh heavily on exports in the coming months, but imports will probably fall by more. Some coronavirus effects crept into February’s official data. The swing in the trade in goods and services balance from a £2.4bn surplus in January to a £2.8bn deficit in February was probably related to the virus (14). After all, it was largely driven by a £2bn fall in exports of non-monetary gold and a £3bn leap in imports of non-monetary gold, probably related to the financial market turmoil.
  • Meanwhile, the suppliers’ delivery times balance of the manufacturing PMI fell off a cliff in March and April (15). And the number of cargo ships arriving at UK ports has dropped back in the first few weeks of April (16).
  • But widespread lockdowns mean that plunging demand, rather than supply disruption, will be the main drag on trade. Admittedly, demand from China now seems to be recovering, albeit fitfully. But the euro-zone and US account for a much larger share of UK exports, at 45% and 19% respectively. So exports may still collapse by more than 10% in Q2 (17 & 18). And with most of the domestic economy still closed, import demand will probably contract even further, perhaps by as much as 40% (19).

Chart 14: Trade in Goods & Services Balance (£bn)

Chart 15: Manufacturing Suppliers’ Delivery Times

Chart 16: Number of Cargo Ships Docking at UK Ports

Chart 17: World Goods Trade & UK Goods Exports (Volume, % y/y)

Chart 18: Manufacturing PMI & Export Goods Volumes

Chart 19: UK Domestic Demand & Imports

Sources: Refinitiv, ONS, IHS Markit, Capital Economics


Labour Market Indicators

  • While the government’s Coronavirus Jobs Retention Scheme should limit the rise in unemployment somewhat, the coronavirus recession may still cause it to surge from 4% now to almost 9%.
  • The PMI suggest that the 172,000 rise in employment in the three months to February may turn into a big fall of 6% y/y (20). That could be consistent with the unemployment rate rising from 3.9% to almost 9.0%, which would mean about 1.7m jobs lost (21). Indeed, 3m people work in hotels, restaurants and recreation, which are the sectors hit hardest (22). And the DWP reports there were almost 2m new Universal Credit claims in the first six weeks of lockdown compared to 0.4m in the previous six weeks (23). Not all will be eligible, and some will be pursuing non-unemployment benefits. But it’s still consistent with lots of job losses.
  • Moreover, many of those employees who have kept their jobs are facing pay cuts. The government’s furlough scheme, which pays 80% of wages up to £2,500 a month, has registered around 6.3m workers. As a result, average earnings won’t fall as far as hours worked (24). However, millions of workers will still face a 20% pay cut and bonuses will be slashed. That could mean average earnings fall by 6% y/y, well below the 1% y/y indicated by surveys (25).

Chart 20: Employment PMI & Employment

Chart 21: Unemployment Rate (%)

Chart 22: Employment by Sector (2019, 000s)

Chart 23: New Applications for Universal Credit (000s)

Chart 24: Total Hours Worked & Average Earnings (% q/q)

Chart 25: REC Jobs Survey & Average Weekly Earnings

Sources: Refinitiv, IHS Markit, REC, DWP, Capital Economics


Inflation Indicators

  • Deflation, not high inflation, may be the more pressing concern for the Bank of England for the foreseeable future. We expect the plunge in energy prices and weak demand to drag down inflation to around 0.5% by the Autumn. That would require the Bank of England Governor to write to the Chancellor explaining why inflation is more than 1ppt away from the 2% target. And a brief period of deflation is possible.
  • Energy prices will knock off about 0.9ppts from CPI inflation in the coming months as utility prices are cut in response to past falls in wholesale energy prices and the plunge in oil prices to £16pb in April feeds through to fuel prices at the pumps (26 & 27). If oil prices stay at current levels rather than rise to £36pb as we expect, that would subtract a further 0.3ppts from CPI inflation this year (28). Meanwhile, stockpiling in March does not seem to have boosted food inflation, which may fall to zero later this year (29).
  • Core inflation is likely to remain subdued too as exceptionally weak demand more than offsets any supply-driven upward pressure on prices. The 1.2% and 0.5% fall in clothing and hotel prices respectively in the year to March are likely to have been early signs of consumers’ cutting their spending. And March’s EC business survey suggests that core goods inflation may slump from +0.6% in March to -2% (30). So even as the energy effects fade next year, total inflation will probably remain well below its 2% target (31).

Chart 26: Contributions to CPI Inflation (ppts)

Chart 27: Oil & Fuel Prices

Chart 28: Brent Crude Price & Cont. to CPI Inflation

Chart 29: Wholesale Prices & Food CPI Inflation

Chart 30: EC Survey & Core Goods Inflation

Chart 31: CPI & Core CPI Inflation (%)

Sources: Refinitiv, ONS, BEIS, Capital Economics


Financial Market Indicators

  • Equities and sterling have regained some of their losses and we expect them to gradually climb higher over the next few years. The FTSE 100 has risen by 15% since its nadir on 23rd March, less than the 27% rise in the S&P 500 (32). This underperformance is at least partly because of the slide in the oil price, which weighs on the energy-heavy FTSE 100 (33). And as the oil price is unlikely to rise rapidly, it will probably be a slow upward climb for the FTSE.
  • Sterling has also revived, rising from $1.15/£ (€1.07/£) in mid-March to $1.25/£ (€1.14/£) currently, but it is still well below the levels before the lockdown was imposed (34). As well as the economic fallout from the pandemic, the pound is probably being held down by the government’s insistence that it will not extend the Brexit transition period beyond the end of this year.
  • In another sign of easing pressures in the financial markets, LIBOR spreads have started to fall back, especially in the US (35). And yields on government bonds have continued to drift down (36). That’s not surprising given the surge in asset purchases by major central banks (37). We think that the Bank of England may expand its asset purchases over the next few months.

Chart 32: Equity Indices (Jan. 2020 = 100)

Chart 33: Brent Crude Oil Prices

Chart 34: Exchange Rates

Chart 35: 3 Month LIBOR-OIS Spreads (bps)

Chart 36: 10-Year Government Bond Yields (%)

Chart 37: Stock of Asset Purchases (1st Jan. 2020 = 100)

Sources: Bloomberg, Refinitiv, Capital Economics


Paul Dales, Chief UK Economist, +44 7939 609 818, paul.dales@capitaleconomics.com
Ruth Gregory, Senior UK Economist, +44 7747 466 451, ruth.gregory@capitaleconomics.com
Thomas Pugh, UK Economist, +44 7568 378 042, thomas.pugh@capitaleconomics.com
Andrew Wishart, UK Economist, +44 7427 682 411, andrew.wishart@capitaleconomics.com
James Yeatman, Research Economist, james.yeatman@capitaleconomics.com