We caught up with our Chief Economist – Mohamed Chaudhri, to explore what has changed in the economy over the last month. Mo shared his views on not only the economic conditions, but also areas which firms should be extra vigilant of – and pay particular focus to in order to ‘weather the storm’.
Could you share your views on what are the key changes in the economy have been over the last month?
This last month we have seen various, and some key, policy announcements. Much of these have centered around the impact brought by local lockdowns which are frequently occurring in regions across Britain.
The Government have responded to the changing conditions through the provision of two key schemes. These two schemes are:
- The job support scheme – open. For businesses who are operational
- The job support scheme – closed. For businesses who are legally required to close
The first positive is that these two schemes are more generous to what was previously in place (e.g.the winter statement announcements). They are aligned to the ‘tiering’ system which is in place which brings different restrictions to social interaction, and business trading.
To give context; if a business is forced to close because they are within a Tier 3 restricted area – for example hospitality – they will lose a 33% of their income. For those in Tier 2, who are open but seeing a reduction in demand – they will lose 27% of their income. These measures are higher, and more positive, to what was proposed in the previous schemes and will make a significant difference to local areas particularly. What’s important for lenders is to understand how these schemes will transpire over the longer term. They create a mechanism to support over the next 6-months but will inevitably end. When they do, its likely we will still see the impact at a later data – for example it will be seen in Q1/2 of 2021, not Q4 as previously expected.
The latest reports suggest the economy is improving beyond expectations – is this inline with your view?
One story which we have seen unfold this last month is around Retail sales. Retail sales are positively improving and are in line with a V shape recovery.
As we stand today, Retail sales are higher than the levels seen pre-covid. However, while positive, the Retail landscape is changing, as such it is also bringing new risks. To elaborate; over 25% of retail transactions are now being made online, a 5% improvement based on what we would usually see. Recovery is therefore dependent on online sales and e-commerce, removing the need for physical stores, and therefore a potential impact for those employed within retail stores.
This is positive, but retail spend is only one part of ‘consumer spending’. Consumer spending considers not only retail, but also service-led purchases, some of which are not ‘tangible’ goods. People are not travelling as they would normally, as such we see a divergence in them using the monies they would have once set-aside to fund their summer travel, to fund more physical goods – DIY and home improvement items for example. The value of these ‘replacement items’ items doesn’t equate to the value a typical holiday would have cost. So we see a decline in overall spending, despite the reported increase in Retail levels. As such, the economy is struggling. It is in an even more precarious position today, to what we say a few months ago.
What are the other key forces impacting economic performance?
The last 3 months has proven to be more resilient to what was previously forecast. While GDP hasn’t grown as much as expected, it also didn’t fall as much as it was forecast to either. It has therefore outperformed expectations. Unemployment, according to official figures is sat at 4.5%. Again a positive measure that shows unemployment levels remain below what was expected.
When you take factors such as these into consideration you could conclude overall the economy has recovered, and performed, beyond expectations. But when you look forward, we can clearly see we are not out of the woods. Instead we are seeing some displacement occurring. While unemployment isn’t at the levels it was forecast, or GDP, we can see an overall trend leading to a slower overall recovery than what was expected. Why? This is predominantly caused by the impact brought by local lockdowns.
With such indifference in economic performance, what is the key takeaway?
The takeaway from this the likelihood of a negative number in Q4 has increased significantly compared to what we saw a month previous.
The ‘local lockdown’ impact seems to be a common theme of emerging change, and risk. How is this influencing economic change – from a regional and consumer viewpoint?
From both a regional and demographic view, we are starting to see signs of a K shape recession.
We haven’t previously seen a ‘K’ in any forecasts – but in short, what it is saying is the recession impact across the country is considerably different. This is caused by the local lockdowns. The impact of this is completely different to what we have previously seen. The recession impact is being felt, and seen, very differently depending on locality or demographic.
The younger groups, for example, are showing in real data a disproportionate impact. Understanding the real impact is a crucial factor for firms to model against and scenario test. By doing so they can better understand how exposed they are to both their existing customer base, but also new lending opportunities. We are continually working with lenders to be able to better understand their economic exposure. To do so we are using account level data in the models which gives a highly granular view of risk, which is much more tangible for firms as it can better help inform credit risk changes and strategies.
As we have seen previous, it seems a continual trend that there is a need to look beneath the headlines – therefore additional analysis is ever more critical. What additional analysis would you say is key to this month’s trends?
You’re right. On the face of its data trends could show a very different picture to reality. But with the continued scale of change – economic and the response measures we have explored, the data isn’t on a clear, linear trajectory. Its volatile. We are continually augmenting our scenarios and analysis with additional, supplementary data. This month we were provided additional data from the ONS, which we have been able to model to show ‘inactivity’ – specifically the rate of.
To put it in layman terms, we can see the people who are unemployed – but have chosen to refrain from seeking new employment straight away. These people are economically active, and not classified as officially unemployed – therefore not showing in official figures. This is therefore a risk area. They are a group who is at risk because they have suffered an income shock and therefore in models, as we have championed many times before, they need to be considered as unemployed and therefore additional exposure.
The analysis isn’t limited to just classifying furloughed employees, but wider. This view has been ours since the start – that real unemployment is much higher than official figures, but recently supported by releases outside of our own. The Resolution foundation earlier this week released a report estimating the real-unemployment rate is currently at 7%. It is evermore crucial to apply scenarios against models which considers the suffering scales of unemployment rate.
As we have previously shared, it’s our assumption that 10% of the furlough population will lose their unemployment – at the end of the current furlough scheme. This week we saw wave 15 of the data come out. This data release confirmed that 9% of the population is still on some form of furlough scheme. This announcement mirrors our assumptions.
I think a good concluding part would be your views on areas of resilience, and risk. Where, who and what is most exposed – or opportune for new lending opportunities?
The story remains the same on which sectors have been hit and are exposed. With the new measures in place, it is delaying the impact that is forecast. The next 6-months, due to these schemes, will see a further buffer given which will delay the eventual outcome. As such unemployment ‘curve’ analysis has been revised to feature Q2, 2021 – being the peak.
When we have delved into our sector forecasts, and which parts of the economy will return to growth first, you can see it is a very differentiated story – depending on sectors. For some, it will take 3-4 years to return, for others we are looking at 3-4 months. There are, of course, implications for commercial lending models to be considered due to the breadth of difference in commercial trade
What would your final concluding parts be to share, Mo?
When you look at what these local discrepancies mean for the economy, you can see a strong correlation between GDP and unemployment. Understanding all causes of change, and risks is ever more important. As is granular analysis which provides additional, supplementary scenarios which firms can model against and identify exposure, and risk.
Another point is that lenders shouldn’t consider Covid-risk independently. Brexit remains a significant influencer of economic performance, and risk.
To expand on the Brexit point; where we are today, we have seen two extensions to the Brexit deadline. The next key date where we will hear anything meaningful will be towards . Its my view this will advise talks need to be continued. Regardless, by the 31st December some form of deal would need to have been agreed. When we have modelled the effects of a no deal Brexit, alongside the impacts of Covid, we start to see a much more granular picture – which is a much more robust view of indicative risk.
When we have done this, food drink and tobacco for example, have seen a positive impact brought by Covid – however the Brexit risk (based on a no-deal), will impact these sectors significantly due to import and export terms.
In our own analysis we haven’t just looked at sectors, we have delved into localities too. By doing the various analyses – and applied against covid-risk – you can start it get a granular and realistic view of how people, business and areas will perform in the near and long term.
I would also like to point people to our furlough tool. We have created a free tool for people to test furlough scenarios against sectors and regions. It’s a means of being able to gain some indicative insight, and is available here. Please note the tool only works in Chrome.