Economic Review – August 2020

Our economic review is intended to provide background to recent developments in investment markets as well as to give an indication of how some key issues could impact in the future.

It is not intended that individual investment decisions should be taken based on this information; we are always ready to discuss your individual requirements. 

FASTER REBOUND; SLOWER RECOVERY

As recent economic statistics confirm the UK officially entered recession, Bank of England (BoE) forecasts suggest the slump will be less severe than previously thought, but the ensuing recovery is likely to take longer.

Data released by the Office for National Statistics (ONS) showed the economy shrank by 20.4% between April and June compared with the first three months of the year. This was the UK’s largest ever quarterly contraction and pushed the economy into its first technical recession – defined as two successive quarters of negative growth – since the 2009 financial crisis.

While the data was undoubtedly grim, it did show the economy’s low point was reached in April when output was over 25% below its pre-pandemic level. It also showed that, as lockdown restrictions eased, the economy bounced back, expanding by 8.7% in June following growth of 1.8% in May.

Survey evidence also suggests this improvement has continued, with the IHS Markit/CIPS flash composite Purchasing Managers’ Index rising to a near seven-year high of 60.3 in August, up from 57.0 in July. However, while this does indicate accelerated growth, it does not signal a return to normal levels of output.

The BoE’s latest economic forecasts released in early August, reinforce this point. Although the Bank said that a faster easing of lockdown restrictions and a more rapid pick-up in consumer spending has helped the economy rebound faster than previously envisaged, it also warned that a slower paced recovery now appears likely.

Specifically, the new BoE forecasts suggest the UK economy will shrink by 9.5% this year, compared to a previously estimated contraction of 14%. The annual growth rate in 2021 has been reduced to 9% from a previous estimate of 15%, which would mean the economy only regaining its pre virus size at the end of 2021.

BOE ‘CONSIDERING’ NEGATIVE RATES

The BoE left base rates unchanged following the latest meeting of its Monetary Policy Committee (MPC) but stated that it was ‘currently considering’ the case for cutting interest rates below zero.

At a meeting held on 4 August, the MPC voted unanimously for no policy change, with the Bank Rate maintained at a record low of 0.1%. In addition, the minutes of the meeting stressed the Bank has no intention of raising rates until there is ‘clear evidence’ that a recovery has taken hold. The minutes also stated that the MPC continues to ‘monitor the situation closely’ and that it is keeping under review a range of possible policy responses.

One potential course of action open to the MPC is to impose negative interest rates in order to provide stimulus to the economy, a path that central banks in both Japan and the Eurozone have gone down. The BoE confirmed they are currently considering whether the Bank Rate could be cut below zero and whether such a policy might prove to be an effective tool in the UK.

However, BoE Governor Andrew Bailey again reiterated that policymakers are unlikely to introduce negative rates at any point soon, partly because such a move could inadvertently reduce bank lending or lead to customers withdrawing their savings and holding them in cash. Additionally, there is a fear the public will find the whole concept of negative interest rates difficult to comprehend.

Commenting specifically on the prospect of negative rates, Mr Bailey said: “They are part of our toolbox… but at the moment we do not have a plan to use them. There would be a lot of explaining to do on what this means, why we’re doing it, and what the benefits would be.”

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