The large share of consumer-facing services in the UK economy, combined with a deeper and longer lockdown than most other developed economies meant that the UK was always going to be hit harder than some other countries. But the larger fall in GDP in the UK means it has the deepest hole to climb out of. What’s more, a second wave of unemployment, now that the furlough scheme is being unwound, more localised lockdowns due to an uptick in virus cases and the additional uncertainty caused by Brexit will probably mean that the UK is slower to climb out of its hole than other countries. As a result, we think that the Bank of England will have to do considerably more QE than it already has to stimulate demand and boost inflation back to its 2% target.
- The large share of consumer-facing services in the UK economy, combined with a deeper and longer lockdown than most other developed economies meant that the UK was always going to be hit harder than some other countries. But the larger fall in GDP in the UK means it has the deepest hole to climb out of. (See Chart 1.) What’s more, a second wave of unemployment, now that the furlough scheme is being unwound, more localised lockdowns due to an uptick in virus cases and the additional uncertainty caused by Brexit will probably mean that the UK is slower to climb out of its hole than other countries. As a result, we think that the Bank of England will have to do considerably more QE than it already has to stimulate demand and boost inflation back to its 2% target.
- Output & activity indicators show that despite the easing in the lockdown, GDP is recovering very slowly.
- Household indicators suggest that although retail sales have recovered, total consumer spending will take much longer to reach its pre-pandemic levels.
- External indicators imply that exports will recover more quickly than imports.
- Labour market indicators show that the furlough scheme has limited the rise in unemployment, but a second wave is on the way now that the scheme is being unwound.
- Inflation indicators suggest that CPI inflation will briefly fall into negative territory.
- Financial market indicators show that the slow recovery in the UK is acting as a drag on UK equities.
Chart 1: Change in GDP Between Q4 2019 & Q2 2020 (%)
Sources: Refinitiv, Capital Economics
Output & Activity Indicators
- The recovery has been underwhelming so far, and a resurgence in the virus could damage it. GDP rose by just 1.8% m/m in May leaving output 24.5% below its pre-virus level (2). While the manufacturing sector was able to recover somewhat as the government urged them to reopen in mid-May, services activity remained hamstrung by lockdown restrictions (3).
- Timelier data for June point to a more meaningful rebound. Car production recovered to about half of pre-virus levels (4). And according to the ONS Business Impact of Coronavirus Survey (BICS) the number of firms closed fell, and those open recorded improving revenues. That pushed up our BICS Indicator to a level consistent with a 7% m/m rise in GDP in June (5).
- No doubt the recovery has continued since then given the further easing of the lockdown in July, when pubs, restaurants and hairdressers reopened. Indeed, the number of people eating out was up by about 10% y/y at the start of August due to the “Eat Out to Help Out” scheme (6). The big risk is that more activity leads to higher transmission of the virus, as has been the case in Spain and the US (7). That could cause the recovery to stall and, if it were to lead to lots of localised lockdowns and the closure of some sectors, a double-dip recession.
Chart 2: Level of GDP (February 2020 = 100)
Chart 3: GVA by Sector (% Change vs. February)
Chart 4: SMMT & ONS Car Production
Chart 5: CE BICS Indicator & GDP
Chart 6: Number of People Dining at Restaurants (% y/y)
Chart 7: New Virus Cases per 1,000 People (7-Day Ave.)
Sources: Refinitiv, ONS, CE, OpenTable, CEIC
- Despite the “V” shaped recovery in retail sales, more timely indicators suggest that the recovery in total consumer spending is likely to be more gradual. The 14% m/m gain in retail sales volumes in June took sales to just 0.6% below the pre-crisis level (8). The recovery was supported by strong volumes of online sales and a pickup in non-food sales, but non-food sales remained well below the February level (9).
- Indeed, footfall in UK city centres was still significantly below pre-virus levels in mid-July (10). Admittedly, there are signs that consumer spending outside of the retail sector is starting to rise as well. Car registrations picked up in July (11) and the drop in household’s total unsecured borrowing in June was much smaller than in previous months (12).
- But heightened consumer caution and social distancing requirements are likely to mean the recovery of non-retail consumer spending, such as cinema tickets and other forms of entertainment, will stay slow. Indeed, consumer confidence remained low in July. Consumers indicated that they are reluctant to spend on major purchases and plan to save more in the next 12 months (13). As a result, total consumer spending will likely remain below pre-crisis levels for a few years yet.
Chart 8: Retail Sales Volumes (2016 = 100)
Chart 9: Retail Sales Volumes (Feb 2020 = 100)
Chart 10: Footfall in UK City Centres (% y/y)
Chart 11: Private Car Registrations (Seas. Adj., 000s)
Chart 12: Unsecured Household Borrowing (£bn)
Chart 13: ESI Consumer Confidence
Sources: Refinitiv, Springboard, EC, Capital Economics
- Exports and imports are likely to recover as lockdowns are eased around the world, but a more gradual recovery in imports means that net trade should provide a boost to GDP growth this year. The UK’s trade surplus soared to £4.3bn in May, its largest level since December (14). This was largely driven by a £3.8bn surplus in trade in the volatile non-monetary gold component. But after excluding non-monetary gold, export volumes in May were 29% below February’s level, while import volumes were 31% below (15).
- Imports and exports probably rose in June and July. Indeed, the number of cargo ships docking at UK ports rose from a low of 587 per week in April to an average of 666 per week in July (16). And the surge in the export orders PMI suggests that goods export volumes will rise rapidly in Q3 (17). Indeed, the recovery in global GDP growth will help exports to bounce back strongly over the next year (18).
- Perhaps ironically, Brexit may help to support the recovery in trade volumes. The transition period is due to end on 31st December 2020. In the run up to previous Brexit deadlines, stockpiling boosted both exports and imports (19). But this would only be a temporary boost. Even the slim Brexit trade deal that we are expecting would probably constrain trade flows in 2021 and a no deal would hit them even harder.
Chart 14: Trade in Goods & Services Balance (£bn)
Chart 15: Goods & Services Trade Volumes (Exc. Non-Monetary Gold, £bn)
Chart 16: Unique Ships Docking at UK Ports (Weekly)
Chart 17: Manufacturing PMI & Goods Exports Volumes
Chart 18: Trade Partner GDP & Export Volumes (% y/y)
Chart 19: Export & Import Volumes (£bn, Inc. Valuables)
Sources: Refinitiv, ONS, IHS Markit, Capital Economics
- The success of the furlough scheme and a rise in inactivity have limited the increase in unemployment so far, but bigger rises lie ahead. Admittedly, employment fell by 360,000 (1.1%) between February and May (20). But employment has not fallen anywhere near as far as GDP (21). And inactivity rose as vacancies plunged (22), meaning that the ILO unemployment rate stood at 3.9% in May, no higher than in February.
- What’s more, the timelier data suggest that the first wave of job losses ended in June. The rate at which the number of employees paid through Pay As You Earn (PAYE) slowed from a 124,000 m/m decline in May to a 74,000 m/m drop in June (23). And following a 1.4 million surge from 1.2 million in March to 2.7 million in April, the claimant count (the number of people receiving unemployment benefits) ticked down by 28,000 in June (24).
- Even so, we expect another wave of layoffs now that the furlough scheme has started to unwind. Recent survey evidence suggests that by 12th July, 4 million of the 9.5 million employees may have returned to work (25). Of the 5.5 million employees left on furlough, we think about 15% may lose their jobs. And the jobless rate may rise further as discouraged workers are tempted back. We expect the 1% fall in employment so far to grow into a 5% fall and the unemployment rate to reach a peak of 7% in mid-2021.
Chart 20: Employment (000s)
Chart 21: GDP & Employment
Chart 22: Recruitment Difficulties & Job Vacancies
Chart 23: PAYE Employment (000s)
Chart 24: Claimant Count & ILO Unemployment (000s)
Chart 25: ONS Survey of Change in No. of Jobs Furloughed (000s)
Sources: Refinitiv, ONS, DWP, Capital Economics
- After briefly dipping into negative territory in the coming months, CPI inflation should rise as the impact of the collapse in oil prices fades. But we don’t think it will reach the MPC’s 2% target. CPI inflation ticked up in June, from 0.5% to 0.6%, but it is still down sharply from 1.8% in January (26). That’s mainly due to the collapse in energy prices. Household energy bills and fuel prices (part of transport) have fallen (27).
- The cut to VAT in the hospitality sector and the Eat Out to Help Out (EOHO) restaurant discount scheme may be enough to drag inflation into negative territory by August (28). Thereafter inflation should rise as the EOHO scheme ends in September, the VAT cut is reversed in January, and the drag on inflation from the collapse in the oil price fades (29).
- Others have raised concerns that the jump in broad money that has resulted from the Bank of England’s rapid asset purchases will fuel high inflation (30). But we think weak demand will be the main influence on inflation, as it prevents retailers from raising their prices (31). We expect inflation to be closer to 1% than 2% by the end of 2022.
Chart 26: CPI Inflation (%)
Chart 27: Contribution to Change in CPI Inflation Since January 2020 (ppts)
Chart 28: CPI Inflation (%)
Chart 29: Oil Price & Fuel Cont. to CPI Inflation
Chart 30: Broad Money & Inflation
Chart 31: EC Survey & Core Goods Inflation
Sources: Refinitiv, Capital Economics
Financial Market Indicators
- While other developed market equity price indices have continued to make gains over the past month, the FTSE 100 has stalled and even gone into reverse recently (32). That partly reflects the relatively slow economic recovery in the UK. But it is also due to the oil, gas and financial sectors, which have a large weighting in the FTSE indices and have been laggards in the recovery (33).
- In contrast, sterling has rallied, rising from $1.25 at the end of May to $1.30. However, most of this is due to weakness in the US dollar. The pound has only risen slightly against the euro (34). Indeed, the odds of the Brexit transition period being extended beyond 31st December 2020 have risen from around 25% at the start of July to about 33% at the start of August, which has pushed up the pound to €1.11 from €1.09 in recent days (35). We still think that there will be an agreement which prevents a major step change in trading relations at the end of 2020. That could push up the pound to around $1.35 and €1.13.
- Meanwhile, LIBOR rates have continued to fall (36). That’s not surprising given the market is increasingly expecting the Bank to cut interest rates from +0.10% to below zero over the next year (37). We wouldn’t rule out negative interest rates but we suspect most of any more stimulus will come in the form of QE. In total, we think that the MPC will expand QE by £250bn, which is more than the consensus forecast.
Chart 32: Equity Indices (Jan. 2020 = 100)
Chart 33: FTSE All-Share Sectors (% Change)
Chart 34: Exchange Rates
Chart 35: Prob. of Transition Period Extension & €/£
Chart 36: LIBOR Rates (%)
Chart 37: Interest Rate Expectations (%)
Sources: Bloomberg, Refinitiv, Capital Economics
Paul Dales, Chief UK Economist, +44 7939 609 818, email@example.com
Ruth Gregory, Senior UK Economist, +44 7747 466 451, firstname.lastname@example.org
Thomas Pugh, UK Economist, +44 7568 378 042, email@example.com
Andrew Wishart, UK Economist, +44 7427 682 411, firstname.lastname@example.org
James Yeatman, Research Economist, email@example.com