The UK Economy: How bad is it?

It’s official. We’re in recession for the first time in 11 years. The UK economy contracted by over 20 percent in Q2. Yet retail sales are on the up and the UK economy is actually growing again. Victor Hill finds reasons for cautious optimism.

Hard Times

On Wednesday (12 August) the ONS released the official figures for the performance of the UK economy during the second quarter of 2020. They showed that, relative to Q2 2019, the economy had shrunk by 20.4 percent. This extraordinary figure was not unexpected given that the UK-wide lockdown was imposed in the last week of March and only relaxed – in England at least – in the second week of May. People were not actively encouraged to get back to work until June – even though most people remained confined – and the pubs and hair salons didn’t re-open until 04 July. This being the second consecutive quarter of negative growth, economists declared solemnly that the UK is now formally in recession. Mr Sunak, normally a cheerful soul, spoke of hard times ahead.

The main question is why the UK Q2 figure is so much worse than that of our peers such as France which also endured a rigid lockdown over much of the second quarter. There are two main reasons. First, Britain locked down a few weeks later than our European neighbours and emerged from lockdown several weeks later: hence our Q1 figures were better but our Q2 figures worse. Second, Britain’s economy has a relatively high dependence on consumer spending and services. If you add the Q1 to the Q2 figures, then Britain has fared slightly better than Spain – not that that is much consolation.

The overall Q2 figure masks the fact that while the economy fell year-on-year by around 20 percent in April it grew month-on-month by eight percent in June. And, month-on-month, it was up another eight percent in July. For all that, according to Pantheon Macroeconomics, the economy now is operating at a level 12 percent down from the beginning of March.

Reasons to be cheerful

Last week – before the dreadful GDP statistics were formalised – the Bank of England issued a report which was, given the circumstances, remarkably chipper. The Old Lady observed that a strong rebound is taking place in parts of the economy. Consumer spending is running at about 10 percent below “normal” levels, having been about 40 percent down in April. The housing market is recovering. Most furloughed staff are back at work.

That said, economic capacity has taken a hit. Not every restaurant or pub has re-opened; airlines and others are still laying off staff. The expected surge in unemployment is yet to happen. The Bank anticipates that unemployment will reach 7.5 percent in Q4 (so about 2.5 million) – which is lower than after the financial crisis of 2008-09 when unemployment in the UK reached 8.5 percent. And the Bank reckons that unemployment will only get back to pre-pandemic levels in 2022 – assuming, of course, that further lockdowns prove unnecessary.

Many analysts regard this prognosis as optimistic. Danny Blanchflower, a former member of the Bank’s Monetary Policy Committee, said the estimate was much too low and does not consider the surge in school leavers and graduating students who will struggle to find jobs in the current environment.

The Bank took the opportunity to rule out negative interest rates, saying that this would be an ineffective way to stimulate the economy; though, apparently, the policy remains part of its toolkit. And we can expect QE to be sustained until at least the end of this year.

High street banks are under clear instructions to keep on lending despite the impending tsunami of loan losses. UK banks have already set aside £18 billion to cover non-performing loans, with HSBC (LON:HSBA) alone expecting a hit of £13 billion. On the plus side, household finances seem to be bearing up – unlike in 2009-11. The household savings ratio is trending upwards, suggesting that, come the hour (Christmas, perhaps?) there could be a spending bonanza. And overall, the banks, while facing the prospect of lower returns on capital this year, are not distressed as they were in 2008-09.

The service sector grew dynamically in July with the Purchasing Managers’ Index rising from 47.1 in June to 56.5. Construction sites got back to work; car sales spiked with new car registrations up 11.3 percent on July 2019; and footfall at shopping malls rocketed by around 40 percent. The government’s Eat Out to Help Out scheme – a flamboyant gimmick that flies in the face of its so-called obesity strategy – has resulted in a surge in restaurant bookings.

Accelerating trends

Most commentators agree that the pandemic has accelerated the structural shifts from bricks-and-mortar retailing to the online variant and from office-working (and thus commuting) to home-working (with much less use of public transport). Not to mention the move from terrestrial media (newspapers, the BBC, cinemas) to subscription entertainment (Netflix (NASDAQ:NFLX) et al)). And then there is the staycation shift – away from Torremolinos and towards Torquay – which has been amplified by the hot sunny weather experienced in southern England this August. But that could easily snap back once (if) the fear of flying can be allayed.

A survey by Morgan Stanley out last week suggested that the British are the most reluctant people in Europe to return to the office even as the lockdowns are relaxed. And there are those who have been better off being furloughed. Many will need to be coaxed back to the office.

Will the furlough scheme be furloughed?

Unemployment will inevitably rise once the Job Retention Scheme (aka furlough system) is discontinued at the end of October. The question is: by how much? A lot of people, rather than signing on, may choose to become economically inactive, or, if they have sufficient pension pots, to take earlier-than-planned retirement. Many migrant workers might choose to return home: the reverse migration of many Polish workers is a case in point. With no stamp duty on property purchases, people will be more inclined to relocate to find work.

Economists expect that businesses will start shedding jobs as early as September when the government scheme ratchets down from 80 percent of wages (up to a maximum of £2,500 per month) to 70 percent.

Germany, France, Spain, Japan and Australia – amongst others – are extending employment support measures well into next year. (The largesse of the French state will continue until 2022 – naturellement!). The Italian scheme is set to continue until the end of December. Germany plans to unveil a new version of its Kurzarbeit scheme next month.

Mr Sunak has not ruled out some form of extension; but he seems concerned to send the message that the free ride cannot last indefinitely. Q4 2020 is likely to be a tumultuous quarter for UK industry as the Brexit process reaches its climax – with the likelihood of some kind of tariff regime even if there is a deal – and the prospect of having to pay VAT deferred in previous quarters.

Chancellor Sunak’s desire to stem the tide of unemployment is admirable; but Conservative chancellors should not use public money to perpetuate jobs that the market will not sustain long-term. (NB: sandwich shops and cupcake emporia.) Quite rightly, his main instinct is to rekindle economic growth rather than to embrace austerity (which would be politically impossible, anyway); but he knows that there are limits to the extent to which the fiscal deficit can balloon without repercussion.

The structure of British government debt leans in his favour. UK gilts have an average maturity of 14 years – the longest of any major economy: because the UK benefits from a broad and deep financial ecosystem that has a long-term outlook. The UK debt-to-GDP ratio is rising – but it is still better than that of France, Japan, Italy or even of the USA.

I suspect there will be a last-minute extension of the furlough scheme – which might be another reason why Mr Sunak apparently wants to delay the Autumn Budget. But any new scheme will be restricted to specific vulnerable sectors of the economy such as hospitality and entertainment. Furloughed workers will be required to go on training courses or embark on apprenticeships rather than stay at home. There will be grants to fund new start-ups. The furlough scheme has already cost the UK state £31 billion – about equal to the revenue from business rates. The government now needs some return on that investment.

A K-shaped recovery?

Those who can easily work from home (like this writer) have managed to get through the pandemic financially unscathed. The top 20 percent of earners actually saved money during the lockdown by cutting down on holidays, travel and eating out. But lower-income workers have to earn their living in the great outdoors – whether they are bricklayers, glaziers or cab drivers – and these are the people who have been worst affected. And they are less financially resilient. Many lower income workers have had to raid their savings. Apparently, one half of unemployed people have no savings at all.

Hence the talk about the K-shaped recovery wherein the employed and highly skilled continue to enjoy rising incomes but the lower-paid and unemployed are forced to endure further financial hardship.

This increasing divergence between the haves and have-nots will have serious political consequences. But it should be noted that, despite the widespread perception that the Johnson government has mishandled the pandemic and Sir Keir Starmer’s good personal ratings, the Tories still have a 9-point lead over Labour in the latest Survation opinion poll. I’ll explain in forthcoming posts why the UK’s most serious problems are social, institutional and political rather than economic – not least the rise of separatist sentiment in Scotland.

The vaccine chimera

The Russians, so they have announced, have got a vaccine. I have more faith in Russian microbiological science than most commentators: but my point is that we should be wary of any false dawn. We don’t yet know for how long any anti-Covid vaccine will confer immunity; still less if vulnerable groups like the elderly – who are most at risk from Covid-19 – will be able to be vaccinated safely.

The growing cohort of commentators who parrot the idea that everything will be fine once we have a vaccine are deluded. Quite apart from efficacy and safety, it is becoming clear that many people will actively refuse to be vaccinated. The virus is still circulating and indeed the incidence of new cases is increasing across Europe, India, the USA and elsewhere. We have to prepare ourselves for a world in which Covid-19 will still restrict our behaviour (economic and social) for several years to come.

My best guess is that we shall become reasonably inured to the new normal. Much of the evolution of Western civilization since the Enlightenment has been about the management of risk. (This would be a very bad moment to abandon geometry and algebra because they are white-centric.) And where there is risk there is always opportunity.

For all these reasons, the UK stock market seems relatively sanguine, though banks and oil companies remain out of favour. The FTSE-100 rose by 2 percent on Wednesday to close at 6,280; the FTSE 250 gained 0.5 percent to 18,089; and the FTSE All-Share was 1.7 percent higher at 3,494. This despite more bad news on the dividend front. The pound has been on a roll this last week and now stands at $1.31 and €1.11.

The UK economy is not in a good place right now. But we should focus, as the market does, on its upside potential.

***

There’s no doubt that extreme obesity is an important risk factor in Covid-19 related morbidity. But being slightly overweight hardly figures – especially when in the UK obesity is recorded according to the unscientific BMI so that men and women who go to the gym and build muscle mass are admonished for being overweight.

The current obsession about obesity misses all the lifestyle factors beyond the metric of the scales. The obese are generally people who don’t know how to cook; or, as Nigella would say, who don’t know how to eat. Those of us who love food and discuss with our partners over breakfast what we are going to have for dinner are, I would argue, healthier – and happier – even if we probably carry a few more pounds than that nannyish lady who used to run Public Health England (or some such body).

I find it terribly depressing to read that most young families don’t even possess a dining table. No wonder young people snack and graze on food high in sugar, salt and hydrogenated fats. It seems that inspirational Jamie Oliver and the peerless Greg Wallace of MasterChef fame have wasted their efforts: people are far too busy watching telly while eating supermarket muffins to venture into the kitchen and cook a proper dinner.

I don’t want to judge people. But people need to learn how to eat well. Somehow, I did; despite being dragged up in the culinary desert of bombed-out post-war south London. In years gone by, I loved dinner parties; in my seventh decade I find the word “lunch” the most aspirational in the English language.

Leave slightly fat people be.

Let me have men about me that are fat –
Sleek-headed men and such as sleep a-nights.
Yond Cassius has a lean and hungry look.
He thinks too much: such men are dangerous.

– Julius Caesar (1601), by William Shakespeare (1564-1616), Act I, Scene 2.