The Bumpy Road to Recovery

I recently hosted an online event, “In conversation with David Smith”, for our Mid Corporate customers. David is the economics editor of The Sunday Times, and talked about the nature of this unusual recession and recovery, and the challenges that lie ahead.

The coronavirus crisis had pushed the world economy into recession, though it was now pulling out of it. America’s recession as less severe than for most European countries but it provided the backdrop to the forthcoming US presidential election. While the Democrat challenger Joe Biden was well ahead in the polls, pundits were reluctant to call the result, for fear of being wrong-footed as in 2016. A Biden victory would see some easing of global trade tensions and an immediate stimulus to the US economy, which would boost its growth and provide a fillip for the world economy, but there would be less enthusiasm and momentum for a US-UK trade deal.

Smith then described the shape of the UK recession and recovery so far. While this would the deepest recession for a very long time, probably 100 years, it was also likely to be one of the shortest, essentially concentrated in March and April. So, the expected 10% contraction in the economy this year reflected a small drop in GDP in the first quarter, followed by a record fall of nearly 20% in the second.

From the low point in April, most indicators had shown a significant recovery. Purchasing managers’ surveys, which measure business-to-business activity, had shown a return to growth in May, as the economy emerged from full lockdown, which had continued since.

The strongest “V-shaped” bounce had been for retail sales, which by August were not only above February levels, before the virus hit, but also higher than a year earlier. The caveat was that a higher proportion of retail sales was online, and that the improvement was not across the board. Food and DIY had been strong, clothing and footwear relatively weak.

Brining all these together showed that monthly GDP had recovered by nearly 22% between April and August but remained 9% below pre-Covid levels. And, against the upturn in many growth indicators, the labour market picture was downbeat, with a drop of around 700,000 in payroll employment between March and September.

This was one risk to recovery, as the furlough scheme is replaced by the less generous job support scheme. The big risks, however, are from the second wave of the coronavirus, the restrictions imposed in response to it, and how consumers will respond to the increase in cases. 

The recovery had been V-shaped up until the end of September, Smith said, but was now heading into trickier territory. In that context, he would talk about three other aspects of the outlook:

-       What can we expect from the Bank of England, as talk turns to negative interest rates?

-       How will we pay for all this – are we heading for big tax increases?

-       What about Brexit – will it be deal or no-deal?

On the Bank, which has said that negative interest rates are now part of its “toolkit”, Smith said it was important to understand what is meant by that. The rules of finance are not about to be turned on their head, so lenders pay borrowers to borrow, or savers pay for the privilege of keeping money in deposit. The inters rates in question is the rate paid on commercial bank reserves at the Bank. Currently that is at a record low of 0.1% and the Bank is consulting on the impact of reducing it below zero, to provide the economy with an additional boost. But the Bank is nervous about negative rates and, if they were adopted, it would be a signal that the economy was deep trouble. Much more likely is a further extension of quantitative easing (QE), starting in November.

On the question of tax and the budget deficit, the scale of government borrowing this year is without precedent. The budget deficit over the first six months of the current fiscal year is ￡208 billion, compared with a worst-ever full-year of ￡158 billion in 2009-10. The official forecast is for a full-year deficit of ￡372 billion. These figures are causing deep concern in the Treasury. In August it began to float ideas for raising tax, to be signalled in the November budget. They included higher corporation tax (up from 19% to 24%), taxing capital gains as income and reducing higher rate pension relief. But the budget has fallen victim to the coronavirus’s second wave and, while these proposals give a flavour of the kind of tax hikes the chancellor would like – he is constrained by manifesto commitments to not raising VAT, income tax or National Insurance – any tax hikes to pay for the cost of the crisis look to be a long way off.

Finally, Smith addressed the thorny subject of Brexit. At the time of the online discussion, talks between the UK and he EU had been declared over by Boris Johnson and businesses had been told to get ready for a no-deal Brexit. The chances of a deal were, however, still slightly better than 50-50 and, indeed, talks subsequently soon resumed. Even if a deal with the EU is concluded, however, it will be a “thin” one. Optimists would say that any initial deal could subsequently be improved upon, pessimists that this may be as good as it gets.