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Economic Research: The Second Wave And Brexit Will Test The U.K. Recovery

The Return Of The Consumer

The U.K. recovery continues. Just as the lockdown-induced absence of consumers in shops and the wider economy triggered the downturn, the return of the consumer is now igniting a rebound, following the removal of the most severe COVID-19 restrictions. Data available so far suggest the U.K. economy could grow 15% in third quarter, following the unprecedented 20% drop a quarter earlier. We forecast a 9.7% contraction in GDP for this year as a whole and a 7.9% rebound in 2021.

Table 1

S&P Global Ratings' Economic Forecasts For The U.K.
2019 2020 2021 2022 2023
GDP 1.5 -9.7 7.9 3.0 2.0
Household consumption 1.0 -12.2 8.8 3.4 2.1
Government consumption 3.4 -7.0 12.8 1.4 0.7
Fixed investment 0.7 -14.3 9.9 6.0 3.5
Exports 5.0 -11.4 6.6 4.0 2.8
Imports 4.6 -17.6 13.7 5.2 3.0
CPI inflation 1.8 0.7 1.6 1.8 1.9
Unemployment rate 3.8 4.8 6.3 4.5 4.2
10-year government bond 0.9 0.4 0.4 0.7 1.1
Bank rate 0.75 0.23 0.10 0.10 0.10
Exchange rate (euro per GBP) 1.14 1.11 1.08 1.12 1.13
Sources: ONS, Bank of England, S&P Global Ratings.

A Difficult Winter Ahead

Despite the promising start, many hurdles are ahead on the path to recovery, and we now see the economy slightly worse off over the next three years, compared with our previous forecast. Most importantly, COVID-19 is proving hard to beat. The emergence of a second wave of infections in the U.K. has lead the government to introduce fresh restrictions, with further measures likely, at least temporarily. Some restrictions will remain in place until the middle of next year, when we expect a vaccine or effective treatment to be widely available. Even then the virus will not likely be purged entirely, but rather stay with us for some time. Meanwhile, changes in the behavior of consumers and businesses have--at least temporarily--shifted spending patterns. This will weigh on the pace of growth and its distribution across sectors. For example, retail sales as a whole returned to pre-COVID-19 levels in August, but in-store sales were down, and, as a stark reminder of how things have changed in a matter of months, online sales were still up 40%.

Chart 1

image

What will further weigh on growth is the switch in 2021 to a bare-bones agreement on trade between the U.K. and EU, which we continue to assume in our forecast. That could curb the recovery's momentum, particularly in first-quarter 2021, when some degree of trade disruption at customs is likely.

Fresh Government Support Should Offset Most Of the Extra Damage

The furlough scheme ending in October has been crucial in avoiding large-scale unemployment so far, and with it, a loss of household spending power. In conjunction with business funding programs deployed by the Bank of England and the Treasury, it has prevented even greater and longer-lasting damage to the economy than has already been wrought. It is no coincidence that when the government announced new restrictions, it also introduced at the same time a new job support scheme, along with extensions or easing of conditions in its various business support programs. The new German-style short-work scheme, lasting for six months from October, subsidizes employees' pay when they work fewer hours than normal (but more than one-third). The main benefit will be to prevent a spike in unemployment and conserve the relationship between employers and employees until the economy is strong enough to sustain higher employment on its own. However, while still more generous than regular unemployment benefits, the maximum subsidy of 22% of total wages will not do much to prevent a drop in household income and, therefore, will weigh on total U.K. household spending and the performance of the wider economy. In our view, the new support measures, taken together, will be just enough to broadly offset the economic impact of the second wave, with some downsides.

Unemployment Is Set To Rise Markedly, Even With Extended Support

Unlike the furlough scheme, the short-work scheme will do little to help the hardest-hit sectors, most of which already face a much slower recovery than the average, notably travel, transport, hospitality, and leisure, as well as sectors catering to them. And, of course, it cannot reverse the damage already done. In order to survive, some businesses have already cut jobs or will do so in the next months and quarters, as they adjust to the expected weakness in demand ahead and take a longer-term view than the government's job support scheme. We see unemployment (on the ILO measure) rising markedly, from 4.1% in July to a peak of 7.2% in first-quarter 2020, before it declines again.

Chart 2

image

Chart 3

image

The latest unemployment rate numbers, as well as those in our forecast, mask some of the labor market deterioration that has already taken place. Indeed, many who have recently lost their jobs are currently not actively looking for a new one, in view of the extremely unfavorable situation at the moment. This drop in the so-called participation rate means they are not counted as unemployed. If they were, the unemployment rate would be about 1.3 points higher over the next four quarters (see charts 2 and 3).

No Further Monetary Policy Easing For Now

Monetary policy is set to remain extremely accommodative over the next few years. While the Bank of England has appears to have excluded further easing for the time being, in line with its now significantly more positive view of the recovery, the central bank is also unlikely to tighten policy given the weakness in demand and few if any signs of accelerating inflation. Of course, the BoE would likely change its current stance and embark on further easing, though without venturing below zero, if controlling the second wave of infections were to require much more invasive restrictions or if the U.K. and EU were to trade without any deal at all from 2021--both also major risks to our broader macroeconomic forecast.

S&P Global Ratings acknowledges a high degree of uncertainty about the evolution of the coronavirus pandemic. The current consensus among health experts is that COVID-19 will remain a threat until a vaccine or effective treatment becomes widely available, which could be around mid-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.

This report does not constitute a rating action.

Senior Economist:Boris S Glass, London (44) 20-7176-8420;
boris.glass@spglobal.com

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