Further signs that a strong rebound is underway - Capital Economics
UK Economics

Further signs that a strong rebound is underway

UK Economics Weekly
Written by Ruth Gregory

We are encouraged by the signs that a strong rebound is now underway. But the real test for the economy still lies ahead. Indeed, there are still big question marks over how willing households will be to go out and spend if fear of the virus lingers. And we are concerned that a second wave of unemployment will reduce the ability of households to spend. As a result, we suspect that the initial strong rebound will peter out in the second half of 2020 and that the government and the Bank of England will need to do more.

While we were correct in forecasting a peak-to-trough fall in GDP of 25% (see here), recent data suggest that the rebound in economic activity began sooner and has been a bit stronger than we had previously anticipated.

By May, the retail sector had already clawed back almost half of what was lost in March and April. (See here.) June’s PMIs suggest that the economy rebounded strongly after the additional easing in the restrictions on 15th June. (See here.) The high frequency data that we track such as the Apple mobility data, shows that car journeys in the UK have returned to pre-crisis levels. (See here.) And the re-opening of much of the hospitality sector from 4th July bodes well for a continued strong recovery too.

Conditions in financial markets have also generally improved, with government bond yields remaining low and corporate bond spreads almost back to their pre-crisis levels. And notwithstanding the sell-off in recent weeks, the FTSE 100 has recovered almost half of its 33% slump in February and March. (See here.)

As a result, it is increasingly evident that the initial rebound in economic activity has been stronger than we previously thought. Of course, with output likely to be currently running about 15% below pre-virus levels, this by no means suggests that activity is back to normal.

And the real test for the economy still lies ahead. Notwithstanding the uncertainties around the evolution of the pandemic itself, there are still big question marks over how willing households will be to continue to return to pubs, restaurants and hotels if fear of the virus lingers. (See here.) At least if the behaviour of Samuel Pepys after the Great Plague of 1665/66 is anything to go by, then people might be willing to return surprisingly quickly once the coronavirus crisis subsides. (See here.)

But our primary concern is that a reduction in the ability of households and firms to spend will hold back the economy, especially if the winding down of the government’s job furlough scheme triggers a second wave of unemployment. (See here.)

This highlights the challenge for the Chancellor, Rishi Sunak, as the government moves away from phase one, preventing layoffs and bankruptcies, and towards phase two, boosting demand. Rumours suggest that Mr Sunak will announce various measures from his long-awaited national infrastructure strategy in a statement in the week of 13th July. That could provide a bigger pound-for-pound boost to the economy than tax cuts which have also been rumoured. But the economic benefits could take years to feed through. Meanwhile, if people are wary of venturing out, there is no guarantee that the temporary cut in VAT, the government is also considering, will be effective.

Our guess is that Mr Sunak will unveil a package to support certain sectors, accompanied by tax cuts designed to aid the labour market, although the package will presumably be tiny in comparison to the stimulus that we have seen so far. Mr Sunak may even hint that the government will hit the electorate with some tax rises and spending cuts eventually, although we think it will be a long time before the government reins in any fresh borrowing or starts to think about tightening policy. (See here.)

Overall, we are encouraged by the signs that a strong rebound is now underway, but we think that it may well peter out in the second half of 2020. That is why we think the Bank of England will need to announce £250bn more QE by August 2021. And why although the Bank Governor, Andrew Bailey, commented this week about an eventual tightening in monetary policy – namely that he favours unwinding QE before raising interest rates – we think it could be five years at least before the Bank even thinks about tightening policy. (See here.)

Week ahead

The money and credit figures (due on Monday) will bring more signs that businesses are loading up on debt, but households are deleveraging.


Data Previews

GDP National Accounts & Balance of Payments (Q1) Tue. 30th Jun.

Forecasts

Time (BST)

Previous

Consensus

Capital Economics

GDP q/q(y/y)

07.00

-2.0%(-1.6%)

-2.0%(-1.6%)

-2.0%(-1.6%)

Current Account Balance (£bn)

07.00

-£5.6bn

-£15.0bn

-£15.0bn

Household savings rate started to climb

The Quarterly National Accounts are likely to confirm the 2.0% q/q drop in GDP in Q1 and show that households ramped up their savings.

With little reason to expect any major changes to the headline GDP figures already announced for Q1, the main focus will be on the additional information provided on the household sector.

Indeed, the introduction of the furlough scheme on 19th March, which covered 80% of wages, subject to a cap of £2,500 a month, probably meant that real disposable household income “only” fell by about 3.0% q/q in Q1. But households’ ability to spend was limited by the closure of almost all shops, bar and restaurants. As a result, the saving rate probably rose from 6.2% in Q4 to 7.0% in Q1, its highest level since 2016.

Meanwhile, we already know from the monthly data that the trade balance will flip from a 1.4% of GDP surplus in Q4 2019 to a 0.2% of GDP deficit in Q1 2020. A small deterioration in the primary income balance is also likely. Overall, we suspect the current account deficit widened from £5.6bn (1.0% of GDP) in Q4 to £15.0bn (2.7% of GDP) in Q1. That widening will probably prove temporary though. Indeed, as the recent monthly data showed that imports fell more sharply than exports in April, we suspect the trade balance recorded a surplus in Q2. (See Chart 1.)

Chart 1: Goods and Services Trade Values (% m/m)

Source: Refinitiv


Economic Diary & Forecasts

Upcoming Events & Data Releases

Date

Country

Release/Indicator/Event

Time (BST)

Previous*

Consensus*

CE Forecasts*

UK Data Response

Mon 29th

UK

Net Consumer Credit (May)

(09.30)

-£7.4bn

-£2.0bn

-£2.5bn

DR

UK

Mortgage Approvals (May)

(09.30)

15,800

25,000

25,000

DR

UK

M4 Money Supply (May)

(09.30)

+1.5%(+9.5%)

+1.0%(+10.7%)

DR

UK

UK Economic Sentiment Survey (Jun)

(10.00)

61.7

65.0

DR

UK

MPC’s Vlieghe speaks on Macroeconomic Risks

(13:30)

Tue 30th

UK

GfK Consumer Confidence (Jun, Final)

(00.01)

-30.0

-29.0

-30.0

UK

GDP (Q1, Final Est, q/q(y/y))

(07.00)

-2.0%(-1.6%)

-2.0%(-1.6%)

-2.0%(-1.6%)

DR

UK

Current Account (Q1)

(07.00)

-£5.6bn

-£15.0bn

-£15.0bn

DR

UK

MPC’s Haldane speaks on “The Second Quarter”

(11.00)

UK

MPC’s Cunliffe speaks on Central Banking

(15.00)

Wed 1st

UK

BRC Shop Price Index (Jun)

(00.01)

(-2.4%)

UK

IHS Markit/CIPS Manufacturing PMI (Jun, Final)

(09.30)

50.1

50.2

50.1

UK

MPC’s Haskel speaks on Monetary Policy

(12:00)

UK

Treasury Comm. Interviews IMF Chief Economist

(14.00)

Thu 2nd

No Significant Data Released

Fri 3rd

UK

IHS Markit/CIPS Services PMI (Jun, Final)

(09.30)

47.0

47.2

47.0

UK

IHS Markit/CIPS Composite PMI (Jun, Final)

(09.30)

47.6

47.6

47.6

Selected future data releases and events

Mon 6th

UK

IHS Markit/CIPS Construction PMI (Jun)

(09.30)

28.9

DR

UK

IHS Markit/CIPS All-Sector PMI (Jun)

(09.30)

29.9

DR

*m/m(y/y) unless otherwise stated

Sources: Bloomberg, Capital Economics

Main Economic & Market Forecasts**

%q/q(%y/y) unless stated

Latest

Q1 2020

Q2 2020

Q3 2020

Q4 2020

2019

2020

2021

2022

GDP

-2.0(-1.6) (Q1)

-2.0(-1.6)

-23.0(-24.1)

+15.1(-13.2)

+4.5(-9.2)

(+1.4)

(-12.0)

(+10.0)

(+3.7)

CPI inflation

(+0.5) (May)

(+1.7)

(+0.6)

(+0.4)

(+0.5)

(+1.8)

(+0.8)

(+1.0)

(+1.0)

ILO unemployment rate (%)

3.9 (Apr)

3.9

8.5

8.0

6.5

3.8

7.0

5.7

5.3

Bank rate, end period (%)

+0.10

+0.10

+0.10

+0.10

+0.10

+0.75

+0.10

+0.10

+0.10

10 yr gilt, end period (%)

0.17

0.35

0.17

0.25

0.25

0.82

0.25

0.25

0.25

$/£, end period

1.24

1.24

1.24

1.30

1.35

1.33

1.35

1.35

1.35

Euro/£, end period

1.10

1.13

1.10

1.12

1.13

1.18

1.13

1.13

1.13

Sources: Capital Economics, Refinitiv

** Assumes that the restrictions on activity created by the coronavirus lockdown last for three months from late March to late June. Assumes the UK and the EU agree a slim trade in goods deal by the end of the year, with the status quo for services and financial services maintained until a later date. (See here.)


Ruth Gregory, Senior UK Economist, +44 7447 466 451, ruth.gregory@capitaleconomics.com