Recovery underway, but the biggest challenge awaits - Capital Economics
UK Economics

Recovery underway, but the biggest challenge awaits

UK Economics Weekly
Written by Andrew Wishart

The sharper-than-expected rebound in retail sales in May shows that the economy has turned the corner and embarked on the recovery leg at pace. However, the idea that the coronavirus will cause a very deep but ultimately swift and costless recession doesn’t hold water. Our view is that while the initial stages of the recovery will be swift, by the end of the year the damage to the labour market will weigh on demand causing the recovery to slow, inflation to remain low, and the Bank of England to announce further stimulus.

On the road to recovery

The sharper-than-expected rebound in retail sales in May shows that the economy has turned the corner and embarked on the recovery leg at pace. (See here.) The quicker reopening of the economy suggests that GDP might contract by 15%-20% in Q2 rather than the 23% we forecast. Meanwhile, the unemployment rate failed to rise as anticipated in April, instead staying at 3.9%. (See here.)

However, the idea that the coronavirus will cause a very deep but ultimately swift and costless recession doesn’t hold water. The data so far is instead a measure of the success of policymakers in “bridging” across the first and biggest bear trap – the lockdown. But another huge one lies ahead.

The claimant count shows that the proportion of the workforce claiming out-of-work benefits has already hit 7.8%. (See here.) And the government will increasingly shift the cost of the furlough scheme onto employers from August and end the scheme entirely in October. When that happens unemployment will surely rise. (See here.) With 30% of the workforce off work or unemployed in April, the only question is by how much. (See Chart 1.)

Chart 1: % of Workforce Temporarily Away from Work or Unemployed

Source: ONS

It’s possible that a rapid rebound in activity will mean that furloughed workers can all return to work. But many firms have already announced redundancies, and the Bank of England’s “Decision Makers Panel” survey shows that firms expect the coronavirus to cause employment to fall by 10% by Q4. What’s more, some of the shift in consumption patterns caused by the virus reduce demand for some of the most labour-intensive businesses like hotels and restaurants for longer than other areas. The chances of the economy bouncing back quickly enough to prevent unemployment rising when the economy is taken off the life support of the furlough scheme look slim.

At the same time, while our assumption is that the UK and the EU will agree a “slim” trade deal at the last minute, until it happens, Brexit uncertainty will also hold back investment and hiring. (See here.)

Overall, our view is that while the initial stages of the recovery will be swift, by the end of the year the damage to the labour market will weigh on demand and cause the pace of the recovery to slow.

Hopeful Haldane reckons it’s job done

Eight members of the Monetary Policy Committee (MPC) share our concerns, which led the MPC to announce a further £100bn of QE on Thursday. (See here.) Indeed, the MPC is putting less weight on activity and more on the outlook for the labour market. But for Andy Haldane, evidence that a recovery is taking shape was enough for him to vote against more QE.

Having successfully tackled illiquidity in the gilt market, the Committee will buy these extra assets at a slower pace and won’t complete them until “the turn of the year”. That suggests the MPC won’t decide on more until November or December. By that point, we suspect Haldane’s hopes will have been dashed, unemployment will be much higher, and inflation will still be well below the 2% target. (See here and here.) We suspect that the MPC will eventually increase the stock of QE from £745bn to a shade under £1 trillion. (See here.)

Week ahead

The flash PMIs for June (due Tuesday) are likely to show a further increase as the economy opened up a bit more and firms adapted to social distancing.


Data Previews

IHS Markit/CIPS Flash PMIs (Jun.) Tue. 23rd Jun.

Forecasts

Time (BST)

Previous

Consensus

Capital Economics

Flash Composite PMI

09.30

30.0

40.5

41.0

Flash Manufacturing PMI

09.30

40.7

45.0

50.0

Flash Services PMI

09.30

29.0

38.0

40.0

Recovery underway!

June is likely to show a further increase in the composite PMI as the economy opened up a little more and firms adapted to social distancing measures.

The PMIs measure if activity was higher or lower than the month before. The additional easing in the UK’s lockdown since 15th June (the survey period was probably 12-19th June) is likely to mean that the level of activity in June was higher than in May. As such, firms should really reply that activity was stronger, which would push the PMIs above 50.0.

In reality, though, we suspect that to reflect the low level of activity some firms will say that activity “fell” again in June. Indeed, the composite PMI only rose to 30.0 in May, despite output almost certainly rising compared to April. As such, we’ve assumed that the composite PMI rebounded to about 40.0 in June.

As manufacturing firms were encouraged back into work in mid-May the manufacturing PMI probably rose sharply, to perhaps 50.0. Indeed, in recent months the manufacturing PMI has been more resilient than the services PMI. (See Chart 2.) Meanwhile, the services PMI might have risen more modestly to 40.0 as social distancing measures have had a bigger downward influence.

Chart 2: CIPS/IHS Markit PMIs

Source: IHS Markit


Economic Diary & Forecasts

Upcoming Events & Data Releases

Date

Country

Release/Indicator/Event

Time (BST)

Previous*

Consensus*

CE Forecasts*

UK Data Response

Mon 22nd

UK

CBI Industrial Trends Survey (Jun)

(11.00)

-62

-50

Tue 23rd

UK

IHS Markit/CIPS Composite PMI (Jun, Flash)

(09.30)

30.0

40.5

41.0

DR

UK

IHS Markit/CIPS Services PMI (Jun, Flash)

(09.30)

29.0

38.0

40.0

DR

UK

IHS Markit/CIPS Manufacturing PMI (Jun, Flash)

(09.30)

40.7

45.0

50.0

DR

Wed 24th

No Significant Data Released

Thu 25th

UK

CBI Distributive Trades Survey (Jun)

(11.00)

-50

UK

MPC’s Haldane speaks on “Future of Society”

(18.00)

Fri 26th

No Significant Data Released

Selected future data releases and events

Mon 29th

UK

M4 Money Supply (May)

(09.30)

+1.5%(+9.5%)

UK

UK Economic Sentiment Survey (Jun)

(10.00)

61.7

DR

Tue 30th

UK

GfK Consumer Confidence (Jun)

(00.01)

-36.0

UK

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

(07.00)

-2.0%(-1.6%)p

DR

Wed 1st

UK

IHS Markit/CIPS Manufacturing PMI (Jun, Final)

(09.30)

Fri 3rd

UK

IHS Markit/CIPS Services PMI (Jun, Final)

(09.30)

UK

IHS Markit/CIPS Composite PMI (Jun, Final)

(09.30)

*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 (%)

0.25

0.35

0.25

0.25

0.25

0.82

0.25

0.25

0.25

$/£, end period

1.24

1.24

1.25

1.30

1.35

1.33

1.35

1.35

1.35

Euro/£, end period

1.11

1.13

1.13

1.13

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.)


Andrew Wishart, UK Economist, +44 7427 682 411, andrew.wishart@capitaleconomics.com