Jonathan Marriott, Chief Investment Officer
As lockdown restrictions across most of the world are gradually being eased, and equity markets are becoming less volatile, our focus is naturally shifting from COVID-19 developments towards broader topics. On the coronavirus front, the Oxford University trial on Dexamethasone has shown it to be the first drug to reduce the worst outcome for some patients. Whilst this is a welcome development, it is unlikely to be effective enough to encourage a swifter return to normal. Given the flurry of economic data releases and the latest Bank of England meeting, the UK economy has been our primary focus this week.
Economic data releases
Over the past few weeks, we have received a better sense of how large the economic impact of the lockdown policies have been on the UK economy. Last week, the extraordinary fall in monthly GDP showed that the economy contracted by 20.4% in April versus March, unsurprisingly its largest fall ever. In March, we already saw the economy contract by 5.8% versus the previous month, therefore indicating that economic output has declined by over a quarter since the lockdown measures were introduced. Employment numbers this week were, on the surface, surprisingly strong, with the unemployment rate remaining steady at 3.9%. However, the claimant count has increased sharply to 7.8% from 3.5% as at the end of March, and the Government furlough scheme is temporarily putting a lid on redundancies. Sadly, we expect both these to rise substantially by the end of the year, whereby we could see it hovering close to 10%. On a more positive note, retail sales increased more than expected in May, rising by 10.2% versus expectations of a 4.1% increase. There has been a notable accelerating shift towards online purchases, even as restrictions are slowly being lifted. However, compared to last year, retail sales are still down by 9.8%, and as wages are supplemented by the furlough scheme, the recovery in retail sales may be short lived. In this environment, it comes as no surprise that price pressures have abated, with annual the Consumer Price Index (CPI) falling to 0.5%, well below the Bank of England policy objective of 2%.
Bank of England response
The Bank of England met yesterday and held rates at their all-time low of 0.1%, as was widely expected. Whilst there had been some chatter surrounding the potential use of negative rates, the preferred tool at their disposal remains asset purchases. To that affect, they announced that they would increase their purchases of government bonds by a further £100bn, an amount that most investors expected. However, they struck a more hawkish tone on the implementation of the program. Firstly, they announced that the pace of gilt purchases would be slower, as liquidity conditions have improved with the additional purchases expected to run through to the end of the year. Secondly, purchases would be solely for government bonds and not for providing further support to corporate debt. Third, and perhaps most importantly, the Chief Economist, Andy Haldane, was the only dissenter, and voted against increasing purchases at the meeting. Gilt yields rose modestly on the back of these actions, and sterling weakened. Investors have become more attuned to aggressive central bank action, and as they moderate their tone, despite low pricing pressures, there is the risk of increased disappointment.
Whilst the fall in output has been enormous, there are some signs that as the economy opens, we will see a bounce back. How fast and sustainably the economy will bounce back is the most important question. The fiscal tools, such as the furlough scheme and partially guaranteeing of small business loans, will not continue indefinitely. Although more and more businesses are reopening, social distancing restrictions mean that it is unlikely all of them will see anywhere near the level of revenues they collected before the crisis. The UK Government has indicated that it will seek to upskill the economy and use more fiscal tools to absorb some of the job losses. In the background, we still have ongoing negotiations with the EU regarding a new trade relationship. Even though Prime Minister Boris Johnson has engaged more in recent talks, there remain large issues to resolve before the transition period ends. Given less generous government support and potential trade issues ahead, the Bank of England may seek to deploy its toolkit more aggressively, if liquidity conditions do deteriorate or the outlook for the economy sours.
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