HEADING INTO THE WINTER OF THE UK’S DISCONTENT?
Roger Garrett, 28 September 2020
The strong economic rebound in the UK economy during the summer months, which was helped by significant support from fiscal and monetary policies and a gradual return to normal life after lockdown, while encouraging, is so far the easy part of the recovery.
Summer’s lease hath all too short a date
The UK summer is drawing to a close and as winter approaches the UK faces several economic challenges that could see it enter a ‘bad news is good news cycle’, meaning that bad news on the economy is actually good news for financial markets because it may result in the government introducing more fiscal and monetary stimulus to help the recovery.
The post lockdown rebound has seen the economy recover on a trajectory that will have it close to 90% of its pre COVID-19 levels by the end of 2020. However, clawing back the remainder 10% could take years, and will be largely dependent on how many jobs and businesses will be permanently lost from the economy. This recovery path is clearly not helped by the recent sharp rises in COVID-19 cases in parts of the country.
Unemployment looks set to rise
The UK Government’s furlough scheme which has been key in supporting the labour market so far, cannot continue forever. As the scheme is wound down, there’s concern that the underlying health of the labour market is somewhat fragile. A recent survey from the Lloyds Business Barometer suggests only 20% of firms who furloughed staff expect to retain all of them. This is a potential concern as consumption, which is heavily impacted by incomes, will be an important factor in the economy’s recovery.
UK total weekly hours worked between March to May from 1992 and June 2020
Low interest rates are expected to continue
Monetary policy is expected to remain very accommodative for the near future. Quantitative easing and low interest rates are its key tools to keep the economy trucking along. The Bank of England’s has expressed optimism about the strength of the economic rebound, but also offset this optimism with concern that it won’t be maintained. They also have not ruled out negative interest rates, but for now that doesn’t appear to be the preferred approach.
Fiscal policy has played an important part in protecting jobs and businesses as ‘wage support’ puts money in the pockets of consumers. However, fiscal support is not limitless and will be gradually wound down and the speed and scale of the withdrawal will have some impact on the strength of the economy over the next year or two. It is highly likely that more targeted measures will be required for parts of the economy hit hardest by the pandemic such as hospitality and entertainment.
Brexit uncertainty rears its ugly head again
As the economy gradually recovers and the pandemic threat wanes, attention has started to turn back to Brexit negotiations and the possibility of a no-deal Brexit. It is difficult to determine how the negotiations will go but time is running out with the 31 December 2020 deadline approaching.
A no-deal Brexit will hurt the recoveries for both the UK and EU, affecting business confidence, and it may slow growth due to lower employment and trade disruptions. This could hamper both importers and exporters as the longer-term inflationary implications that could arise from higher tariffs and a shortage of goods. A no-deal Brexit would likely be negative for the sterling as well.
What effect will this have on NZ?
The fragile recovery of the UK economy compounded by uncertainty created by the risk of a no-deal Brexit could be problematic for UK financial markets. From a long-term perspective, the sterling looks under-valued but failure to reach a trade deal with the EU will likely lead to a weaker sterling. For New Zealand, trade with the UK represents 3% of exports but the UK will be keen to strike trade deals with as many countries as possible and this could bode well for NZ, particularly in areas of primary produce exports.
For those with investments in the UK
For New Zealand investors, and those many New Zealanders or UK expats who still have pension funds or UK investments, financial markets generally hate uncertainty, so while the UK equity markets and the currency may appear on cheap side, while uncertainty around Brexit exists it is unlikely they will outperform.