articles Ratings /ratings/en/research/articles/200701-economic-research-the-u-k-faces-a-steep-climb-to-recovery-11554730 content
Log in to other products

Login to Market Intelligence Platform

 /


Looking for more?

Request a Demo

You're one step closer to unlocking our suite of comprehensive and robust tools.

Fill out the form so we can connect you to the right person.

If your company has a current subscription with S&P Global Market Intelligence, you can register as a new user for access to the platform(s) covered by your license at Market Intelligence platform or S&P Capital IQ.

  • First Name*
  • Last Name*
  • Business Email *
  • Phone *
  • Company Name *
  • City *
  • We generated a verification code for you

  • Enter verification Code here*

* Required

Thank you for your interest in S&P Global Market Intelligence! We noticed you've identified yourself as a student. Through existing partnerships with academic institutions around the globe, it's likely you already have access to our resources. Please contact your professors, library, or administrative staff to receive your student login.

At this time we are unable to offer free trials or product demonstrations directly to students. If you discover that our solutions are not available to you, we encourage you to advocate at your university for a best-in-class learning experience that will help you long after you've completed your degree. We apologize for any inconvenience this may cause.

In This List
COMMENTS

Economic Research: The U.K. Faces A Steep Climb To Recovery

COMMENTS

History Of U.S. State Ratings

COMMENTS

U.S. State Ratings And Outlooks: Current List

COMMENTS

COVID-19 Impact: Key Takeaways From Our Articles

COMMENTS

Default, Transition, and Recovery: Consumer And Service Sector Defaults Help Push The 2020 Corporate Tally To 147


Economic Research: The U.K. Faces A Steep Climb To Recovery

Table 1

U.K. Economic Forecasts
2018 2019 2020 2021 2022 2023
GDP 1.3 1.4 (8.1) 6.5 2.6 2.1
Household consumption 1.6 1.1 (9.5) 7.4 3.7 2.7
Government consumption 0.4 3.5 2.3 2.8 1.0 0.7
Fixed investment (0.2) 0.6 (12.8) 8.2 4.2 1.8
Exports 1.2 4.8 (15.2) 8.2 4.8 2.7
Imports 2.0 4.6 (15.4) 9.8 6.8 2.9
CPI inflation 2.5 1.8 0.5 1.8 2.1 2.0
Unemployment rate 4.1 3.8 6.0 6.2 4.9 4.7
10-year government bond 1.46 0.94 0.39 0.74 1.15 1.53
Bank rate 0.60 0.75 0.23 0.10 0.20 0.46
Exchange rate (euro per GBP) 1.13 1.14 1.12 1.08 1.12 1.13
CPI--Consumer price index. Source: ONS, BoE, S&P Global Ratings.

As the U.K.'s COVID-19 lockdown restrictions continue to be eased, the economy is emerging from the sharpest recession it has ever recorded. In a matter of weeks, almost all the gains made since the low point of the financial crisis in 2008 were erased. The path to recovery is paved with many risks and headwinds. The most notable of these are further spikes in COVID-19 outbreaks, and the risk of the U.K. and EU failing to come to an agreement about their future trading relationship by the end of this year.

Exiting Lockdown

The U.K. economy and society are now starting to benefit from the ongoing relaxation of restrictions implemented from late March to contain the spread of COVID-19. So-called nonessential shops can now trade again and traffic is picking up (see charts 1 and 2). Large parts of the hospitality sector, which was hit hardest, are likely to reopen in early July.

Chart 1

image

Chart 2

image

This means that the worst of the slump in the economy is now likely to be over. The 20% month-on-month drop in GDP reported by the Office of National Statistics (ONS) for April should soon be followed by outsized positive numbers, although not quite commensurate to the magnitude of the downturn. Even after the most restrictive lockdown measures are lifted, it will take time for demand to return. Businesses and consumers must adjust to the new normal and some degree of social distancing may persist, even if it is not imposed. Some measures are likely to remain in place until the second half of next year--with effects equivalent to about an 8% reduction in normal consumption, in our view. This is when we consider it likely that a vaccine or an effective treatment will be found, manufactured at scale, and distributed.

Rebound And (Limited) Catch-Up

Even under the assumption that some restrictions will continue, we expect GDP growth to rebound in 2021 by 6.5%. This is much stronger than a typical cyclical upswing and notably faster than the upturn that followed the global financial crisis. This is because the health shock is relatively short-lived and external to the economy itself. We expect some catch-up effects will continue to boost growth in 2022, before fading in 2023.

The unlocking of some pent-up household spending will drive the rebound. The household sector as a whole has been accumulating a large amount of savings. Over the March to May period, households paid off debt to the tune of £16 billion (see chart 3)--corresponding to between 7% and 10% of monthly household expenditure. We estimate the savings rate could have climbed as high as 20% in the second quarter of this year, from just 6.2% in the final quarter of 2019, representing a lot of money that is currently going unspent.

Chart 3

image

However, not all of the money saved now is likely to be spent later when households catch up with some consumption forgone during the lockdown. Households will need to resume payments, such as mortgages or personal contract purchases (on cars, for example), that are currently suspended as part of forbearance measures by lenders. Some households will also have to catch up with missed rent and utility payments. Traumatized by the shock of the pandemic lockdown, many households may also continue saving more as a precautionary measure.

Furthermore, households will have varying degrees of ability to catch up with forgone consumption. Lockdown measures have most affected those in lower-paid service jobs. On average, these households spend less on discretionary consumption and had few savings in pre-pandemic times. They will continue to struggle during the recovery.

The return to pre-pandemic levels of economic activity will also be hampered by inevitable damage to the structure of the economy. Some businesses will have failed, or may fail during the recovery phase when demand and revenue will still be weak. During such times, businesses typically need additional working capital to finance inventories and growth. At the same time, banks might be unwilling to extend loans to businesses they consider too fragile and therefore a commercial risk. Across Europe, we estimate that default rates in the speculative-grade category alone could rise to 8.5% by March 2021, from 2.7% in April (see "Related Research" below). This provides some indication of failure rates for the U.K. It does not include unrated small and midsize enterprises (SME), which are more vulnerable. The £28 billion uptake of the government underwritten bounce-back loans targeting these businesses illustrates SME's need of funding for survival.

Chart 4

image

When businesses fail, trading relationships will end, supply chains will be broken, and production capacity will shrink. While the economy is reorganizing itself, these factors reduce its ability to grow. As a result, the rebound from the recession and subsequent catch-up growth will not be sufficiently strong for the economy to regain its pre-pandemic levels, at least not over our forecast horizon to 2023. In the longer term, the picture is less clear. New, more viable and productive businesses may emerge and replace the ones that failed during the COVID-19 crisis, boosting capacity and long-term growth potential.

What's The Post-Brexit Deal?

Our earlier economic forecasts for the U.K. were based on the assumption that the U.K would request an extension to the post-Brexit transition period, so that U.K.-EU trade would continue beyond 2021 as if the U.K. was still a member of the EU single market. We have now revised this assumption. We now believe that both sides will negotiate a core free trade agreement (FTA) similar to the one Canada has with the EU, and start trading under this new regime from 2021. Under such an agreement, trade in goods would be largely tariff-free, but trade in services, with a few exceptions, would not be covered.

Trade in goods, although largely tariff-free, would still be more costly because of other costs, such as more border checks and longer waiting times at customs, rules of origin verification, and generally increased administrative overheads. Similarly, trade in services would also suffer from a greater burden of red tape in the form of licenses, recognition of qualifications, and compliance with individual member-state regulations on top of EU regulation. For example, a U.K. company transporting goods from the U.K. to Greece on a lorry might need a license from each country it crosses.

The shift to a new post-Brexit regime will come at an inopportune time when the recovery from the pandemic is still fragile. While we do not expect this will stall the recovery, we think it will slow it significantly, reducing growth by about 1 percentage point in 2021 alone. By 2023, we forecast the economy will still be 1.7% smaller than if the transition period had been extended.

The main effect will be loss of EU demand for U.K. exports. In addition, although some businesses will need to spend extra to adapt to new requirements, on aggregate, investment spending will suffer due to a weaker outlook. Higher inflation, resulting from a weaker exchange rate and higher import prices, will also weigh on household spending.

Various factors should mitigate the impact. The private economy as a whole is now better prepared than two years ago, when the prospect of losing access to the single market first emerged. This is not to say that it is fully prepared, notably in areas such as building the customs infrastructure. However, extensive monetary and fiscal policy support is already in place. Measures deployed by the Bank of England (BoE) and the government extend to 2021 and, in some areas, even longer. This should prevent any significant impact on markets and, in particular, on funding for otherwise viable businesses.

Finally, since the EU referendum in 2016, net migration from the EU has fallen steadily to just 50,000 at the end of 2019, from 200,000 in 2016. Travel restrictions across Europe during the pandemic will have exacerbated this decline. As a result, the U.K. economy has already even more reduced access to the EU workers it used to rely on. We do not expect a further reduction in EU net immigration beyond this low point, following the establishment of a new trade regime. As a result, there should not be any additional downward pressure on the economy.

Keeping Jobs Alive Now Will Be Key To Recovery Later

The U.K. government's job retention scheme will be key in enabling the relatively swift recovery that we expect to start from early in the third quarter this year. By protecting jobs, it avoids a lengthy and costly rematching process of employees and employers, enabling people to simply return to their workplace. It also protects incomes, so that households will have more to spend immediately when the situation improves. Under this scheme, the government currently pays 80% of employees' regular wage (capped at £2,500 pounds per month). In May, it encompassed 8.5 million workers, more than 30% of the private sector workforce. Absent this scheme, we estimate the unemployment rate could have risen to 20% in May, with a significantly more detrimental impact on the economy over the medium term.

The scheme costs the Treasury an estimated £10 billion each month, or 0.5% of GDP. However, it still makes fiscal sense provided that it is phased out carefully and with the right incentives for employers. Higher fiscal revenues during a speedier recovery make it worthwhile compared with the alternative scenario characterized by high employment, a slow recovery, and lower fiscal revenues (see "European Short-Time Work Schemes Pave The Way For A Smoother Recovery," published on May 20, 2020, on RatingsDirect.

Chart 5

image

Despite the job retention scheme, we still expect a significant number of workers currently furloughed will ultimately be made redundant and forecast the unemployment rate will rise to just under 8% in the second half of the year (see chart 5).

In view of the highly uncertain economic outlook, some businesses will soon need to make decisions about redundancies, despite the scheme running through October. This is particularly the case for larger businesses that expect demand to remain weak for longer, while at the same time facing high operating costs and being subject to a 45-day consultation period that prevents them from laying off larger numbers of staff immediately. Other businesses that are currently trading with the help of government support will make such decisions later, if demand is not strong enough for them to maintain their cost base, including employment.

Policy Support To Prevent Larger Structural Damage

When it became clear in March that the epidemic in China had grown into a pandemic, the BoE and the Treasury were swift to deploy measures to stabilize markets and provide emergency liquidity support. The BoE cut the policy rate to 0.1% from 0.75%, increased the quantitative easing target balance by £300 billion to £745 billion, and introduced the Coronavirus Corporate Funding Facility (CCFF), among others. Under this facility, BoE buys commercial paper directly from corporations that prior to March 1 were rated investment grade, with the Treasury underwriting the risk. These measures were broadly successful in stabilizing conditions and, in some cases, even improving them. Following the enhanced support for SMEs, for example, the effective floating rate charged to these businesses on outstanding loans was 60 basis points lower in May than in February, just prior to the pandemic. For new loans, the charge dropped by close to 240 basis points.

Such liquidity support, similar to the job retention scheme, aims to limit longer-term harm to the structure of the economy. The large nominal uptake of the fully government-underwritten so-called bounce-back loans, totaling £28 billion, illustrates the damage that has been averted for the most vulnerable smaller businesses, at least for now. Capacity is far from exhausted: only one-quarter of the £76 billion approved by the CCFF has been drawn down, and more approvals are in the pipeline. However, at this stage it is too early to assess how effective direct liquidity support will be over the medium term, once businesses need to repay in an environment of still weak demand.

While the measures currently implemented should limit the economic damage and aid a swifter recovery, incentives to encourage greater investment and household consumption would help further. A cut in consumption tax, currently being discussed in the U.K., could relieve pressure on lower-income households, which have been hit hardest, and that way also boost the wider economy.

A Great Deal of Uncertainty Lies Ahead

In view of the extraordinary nature of the current situation, our forecasts are clouded by a great deal of uncertainty and are subject to significant downside risk. It is currently still difficult to say how the pandemic will evolve. While developments in China, South Korea, and New Zealand, among others, are encouraging, an emergence of further waves of infections, such as in the U.S., cannot be excluded altogether now that we see restrictions being lifted further. The coronavirus will likely remain with us until a vaccine or effective treatment is found.

There is also some uncertainty over how, exactly, policymakers in the future will weigh health measures against the needs of the economy, especially if the evolution of the pandemic changes. Nevertheless, it seems almost certain that the government will not resort to as radical a measure as a full lockdown. In any case, we would revise our forecast down significantly if such a second wave were to emerge.

Chart 6

image

Moreover, while we now assume that the U.K. and EU will strike a trade deal by the end of the year, there is always a chance that negotiations will fail and both sides will trade under World Trade Organisation (WTO) rules from 2021. We consider this an elevated risk (see "Credit Conditions Europe: Curve Flattens, Recovery Unlocks," published June 30, 2020). This would further dampen the recovery and also slow growth in the medium term while the economy adjusts to the new business model. A second, bigger wave of infections in autumn, then followed by a switch to WTO trade rules in January would be a perfect storm.

S&P Global Ratings acknowledges a high degree of uncertainty about the evolution of the coronavirus pandemic. The consensus among health experts is that the pandemic may now be at, or near, its peak in some regions, but will remain a threat until a vaccine or effective treatment is widely available, which may not occur until the second half of 2021. We are using this assumption in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

Related Research

This report does not constitute a rating action.

Senior Economist:Boris S Glass, London (44) 20-7176-8420;
boris.glass@spglobal.com
Research Contributor:Christine Ip, London;
christine.ip@spglobal.com

No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.

Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.

To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw or suspend such acknowledgment at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.

S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain non-public information received in connection with each analytical process.

S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.standardandpoors.com (free of charge), and www.ratingsdirect.com and www.globalcreditportal.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.standardandpoors.com/usratingsfees.

Any Passwords/user IDs issued by S&P to users are single user-dedicated and may ONLY be used by the individual to whom they have been assigned. No sharing of passwords/user IDs and no simultaneous access via the same password/user ID is permitted. To reprint, translate, or use the data or information other than as provided herein, contact S&P Global Ratings, Client Services, 55 Water Street, New York, NY 10041; (1) 212-438-7280 or by e-mail to: research_request@spglobal.com.