After the sharpest contraction on record, activity has bounced back. But the risk of a further spike in COVID-19 cases, the impending withdrawal of furlough support, and continued uncertainty over Brexit loom over this recovery.
The COVID-19 pandemic has hammered the UK output. Activity shrank by more than a fifth in the second quarter, plunging the economy into its deepest recession on record.
The impact of the virus-induced lockdown was felt throughout the corporate sector. Construction was badly hit, contracting by more than a third, while services output fell by a fifth. Within services, the food and accommodation, travel, retail, and education sectors saw dramatic declines in activity. Manufacturing output also shrank by a fifth—driven by a 50% drop in the production of cars and other transport equipment following widespread factory closures.
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A longer lockdown and an outsized consumer services sector—which bore the brunt of social distancing measures—meant that the United Kingdom suffered a bigger slump in second-quarter output than its major European peers.
But higher frequency data show that we are past the worst.
A recovery has been underway since May (figure 1), picking up steam in recent months. Warm weather, pent-up demand, a rise in staycations, and government support—which includes discounts at restaurants—seem to have provided a much-needed boost to activity over the summer.
Retail sales rose above prepandemic levels in July while manufacturing and services output grew at its fastest pace in five years (figure 2). The housing market also recovered its losses, with house prices back to levels seen in January, supported by a stamp duty holiday. These, and more recent data, point toward a strong bounce back in the third quarter.
In addition, planned adjustments to education sector statistics and a likely rise in routine health care provision—which had been reduced to focus on COVID-19 patients—should contribute to a convincing rebound in output.
Yet risks remain. A sustained recovery is predicated on keeping infections under control—something that can hardly be guaranteed. The summer rebound was made possible by a slow rise in COVID-19 cases and a drop in the case fatality rate and mortalities, despite the easing of the lockdown. Increased testing, better treatments, and shielding seem to have resulted in improved outcomes, raising hopes of a better balance between controlling the virus and supporting growth over the coming months. But a sudden surge in new cases or fatalities could easily put paid to plans for further normalization of activity.
Another turning point could be the termination, in October, of the government’s furlough scheme, which has supported jobs and incomes so far. This is widely expected to trigger job losses, with the Office for Budget Responsibility expecting unemployment to rise above 10% this year, potentially slamming the brakes on the consumer recovery.
In addition, there remains continued uncertainty over the terms of Britain’s effective exit from the EU at the end of this year. The risk of a “cliff-edge” Brexit—where the United Kingdom and the EU part ways without an agreement, resorting to trade under WTO rules—is far from eliminated. Going by the corporate response to a potential “no-deal” Brexit in March last year, the risk of future trade disruptions could trigger some stockpiling, displacing activity from the first quarter to the fourth.
It is perhaps due to these headwinds that CFOs of Britain’s largest businesses report elevated levels of external uncertainty (figure 3) in the latest Deloitte CFO Survey. They anticipate a slow recovery, one in which corporate revenues and activity remain below normal levels for a protracted period.
This fits with our own assessment of economic prospects. Our base case scenario assumes a loss in momentum after a strong third quarter, with activity reaching prepandemic levels only in 2022. There are chances of a positive surprise—in the form of a breakthrough in vaccine trials. Until such a development, effective management of the pandemic and continued policy support will be crucial to sustaining this recovery.