We’re still really only at the start of this crisis. It began in late January, we’re now at the end of March. Although March does feel as though it has been 1000 days long!
Each day we’re all hyper-sensitive to the daily updates on cases and deaths in the UK and around Europe. There does seem to be some glimmers of hope emerging, although scientists are quick to manage expectations right now.
On the flip side of this awful coin is the financial sacrifices we are making to help save lives. We are now starting to build up a picture of what lies ahead for the UK and around the world. It does not look pretty.
Today the Centre for Economics and Business Research released this press release, in which I want to analyse a few points:
- The UK economy is about to enter the deepest recession since the financial crisis, including the steepest quarter-on-quarter decline in economic activity since comparable records began.
- We expect the economy to have contracted marginally in the first quarter of the year, by 0.5% QoQ. This, however, is expected to be followed by a much steeper contraction of 15% in GDP in the second quarter as business closures take their toll (the previous largest quarterly fall in GDP from the current records which only go back to 1997 was 2.2% in Q4 2008).
- Our central assumption is that restrictions on businesses and the wider populations will be loosened by the third quarter as testing becomes more widely available, helping to identify and isolate infection hotspots more efficiently.
- We also expect the government to introduce measures to kick start consumer spending as the economy returns to work, possibly a temporary VAT cut. We also are expecting measures to encourage business investment which otherwise will take till after 2030 to get back to its previous peak.
- This will lead to a sharp bounce back in the third and fourth quarter of the year. Over 2020 as a whole we expect GDP to be 4% lower than in 2019.
- On the assumption that further government measures are applied to kickstart consumer spending in the second half of 2020, we expect GDP growth to recover to 3.5% in 2021 and 2.5% in 2022.
- We expect the unemployment rate to jump sharply to reach 7% in Q3 2020 despite government measures to slow the rise.
- With rising unemployment and an increase in the number of people relying on benefits to top up their incomes and many shops closed, household consumption will experience a substantial hit in the second quarter of the year, declining by around 15% on the quarter. Although we expect a recovery in the second half of the year, consumer spending will be about 5% lower in 2020. We expect a rise of 4% in 2021.
- The biggest proportional hit to the economy is likely to come from falling business investment. We predict this will be down 13% in 2020. Although there will be a recovery, the forecasts suggest it will take till 2032 for business investment to catch up with its 2017 peak unless measures are taken to encourage it.
- House prices are likely to fall sharply. Our predictions show a drop of 13% in the year to Q1 2021. By 2022 despite the economic recovery our forecasts show house prices 15% down from their peak.
- Although inflation will remain low during the coming months, we see rising inflation in 2021 and 2022 with the CPI hitting a peak of 3.2% in Q1 2021.
- Interest rates are likely to rise in 2021 in response to higher inflation. We see base rates reaching 3% by 2022.
- Government borrowing is likely to reach £180 billion (7% of GDP) in the current 2020/21 financial year before falling back to £120 billion (5% of GDP) in 2021/22. The debt to GDP ratio is likely to reach 100% of GDP in 2021 and this will not include loans to companies that are eventually likely to have to be written off.
Not much happy reading there at all. They say we’re about to enter the deepest recession since the financial crisis. If you look at some charts based on early data, all the signs are there is that its going to be worse than 2008.
What I have noticed is that each time the next round of predictions and analysis comes through, it gets worse, any by quite a margin. I remember at the start of all this, many saw a “short, sharp shock” and then a quick v-shape recovery. We used that terminology in 2008, and it took ten years to get back to where we were. Now, analysis shows whats coming, or what might already be here, is worse, and I am seeing less mentions of v-shape or u-shape recoveries. This report explains why.
Could Q2 GDP really drop 15%? It would be a record. I actually think it could be more. Remember, we were warned at the weekend that lockdown could extent until early June, late May if we’re being hopeful. Thats even when we’re passed peak. The effect on GDP of an economy effectively put on hold could be a lot worse than than 15%. In the US, some banks are doubling that figure in their predictions for the US economy.
The point about household consumption is worth noting as well. It predicts a major drop in Q2, with an overall drop of 5% for the year. Whilst I think Q2 might be in the right area, I am hopeful that a campaign to support local, British business will help lift those figures in the second half of the year and outpace this report.
They make the assumption that restrictions on businesses and the population will be loosened. Hopefully that’s an assumption that can be adjusted. SAGE has already published details on social distancing, adding that they’re likely to be needed for the rest of the year. So whilst we might be able to go back to work, I suspect that mass gatherings, sport with fans, even pubs and restaurants might well be closed until the end of the year. The Government cannot afford for this effort now to be wasted later, so expect a VERY gradual scaling back of restriction. Personally I think Q3 is still a bit optimistic.
12 years to recover business investment
Perhaps the starkest warning out of the entire report is that it may take 12 years for business investment to recover to the high point in 2017. Business investment drives a huge part of UK economic growth, and any shock to that particular system means we all feel it in one way or another.
Business investment is what drives growth in a lot of companies. It pays for the hiring of new staff, new equipment, training etc. With the domestic and global outlook about as uncertain as it ever has been, it will take a lot of Government action and incentive to get investors spending again.
What did get my attention is their idea that Government could lower VAT to encourage us all to get spending again. A nice idea, and I would love to see VAT lowered to 5% for energy saving windows and doors. But I’m not sure whether its possible. The amount of money being borrowed to spend on the various packages announced in the past few weeks is immense. If VAT was lowered, the tax lost would have to be made up from somewhere else. This time round though, austerity measures to return balance to the books might not be chosen. Politically, it would be disastrous for Boris at the next election in five years time. But philosophically, I do feel as though things have changed. This crisis is going to change our way of life in so many aspects, including money.
In the Cameron era, the era of austerity was brought in to balance the books after the financial crisis and over-spending by Labour. It worked for some, but not for all. In general we got to the end point of that idea. But now we face a new crisis, not once centred around money, but it will be money that repairs the damage in a lot of ways. Health, the NHS, the entire care system and our human values are now front and centre. Significantly more money will be spent in this area. A vote winner in the areas Boris won in last year’s election. The definition of front line workers and key workers will be dramatically changed. I have always seen Boris as more of a spender, not your typical tight Tory. I suspect his Government will be happier to sit on more debt and spend more after all of this.
You can view the entire Cebr press release here: https://cebr.com/reports/uk-gdp-expected-to-contract-by-15-in-q2-as-consumers-under-lockdown-rein-in-spending/
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