An economic review: Six months on – looking back to look forward

A reflection of 4 key performance indicators

The last six months have been unprecedented by any measure. We’ve seen entire economies locked down overnight. Governments have been forced to provide record levels of support for businesses, with over 30% of the workforce being paid directly by the state. Here, we reflect on the performance of four key indicators since March, and then look ahead to see how the second national lockdown will impact the economy.

GDP

Uncertainty weighs down on economic growth.

In the past uncertainty has been centred around general elections or the breakout of other geopolitical events. Covid-19 related uncertainty is no different in terms of its impact on growth. The latest GDP data for 2020Q2 has confirmed that the UK economy suffered its deepest recession on record. This is a recession which has impacted all industries, but some have been hit harder than others as highlighted by the index of services which is still significantly lower than where it was pre-lockdown.

Over the coming weeks, we will see our first estimate of growth in the third quarter of 2020. We expect this to show record levels of growth, but overall GDP is still going to be much lower than where it was in December 2019.

Looking ahead, the greatest risk to the economy is still concentrated in the consumer-facing sectors. There is now a need to understand local economies. Credit lenders need to understand their exposure to parts of the country which are most reliant on those consumer-facing sectors to truly understand how the recovery, or lack of it, is going to impact their borrowers and portfolio.


Unemployment

Even in the absence of the pandemic, we were forecasting an outright rise in the unemployment rate. This was due to the number of vacancies falling in January and February this year. With the onset of the lockdown, our forecasts for the unemployment rate have increased further. It is key to understand the relationship between arrears and unemployment. We have found that most of our clients are unsure that their models are accurately accounting for this relationship.

The official unemployment rate is about 4.5%. However, there is a significantly different impact at the socio-demographic level; people who are in lower-skilled occupations such as the accommodations and food sector or recreation and leisure sector have been disproportionately hit. Younger people too have been harder hit, as they are more likely to be working in consumer-facing industries.

As noted in previous articles, we have developed our view on the ‘true’ unemployment rate. We’ve got in touch with the Office of National Statistics (ONS) directly, and they have confirmed that there is a record-high number of people who are temporarily away from work. These people do not feature at all in the ONS’s definition of unemployment, leading to an underestimation of the ‘true’ unemployment rate in our view.

The ONS definition also requires an individual to be actively seeking work to count as unemployed. Again our ‘true’ unemployment rate does not necessarily satisfy this condition. As credit market practitioners, we focus on whether somebody has lost a job and as a result suffered an income shock, which in theory should translate to that individual being at a greater risk of falling into arrears.

We are forecasting the unemployment rate to reach its highest level in 30 years to above 8%. It could be argued that this is actually a record high given the structural changes seen in the labour market over recent years.


Interest rates

There was a double shot in the arm of the economy with the Bank of England first cutting rates to 0.25% and then to a record low of 0.1%. The Bank of England has made clear that it is reviewing the case for negative interest rates. Negative interest rates, in theory, make it more costly for banks to hold money with the Bank of England, therefore incentivising banks to lend more money to businesses and households. The Bank has many other options in the toolbox, which in our view are more likely to be successful such as forward guidance and quantitative easing.


House prices

In the first few months of the lockdown, the housing market came to a sudden halt as completions were postponed. House prices fell back according to the Nationwide House Price Index, as Covid-19 related uncertainty undermined confidence. However, in July, the Chancellor announced a stamp duty holiday, providing much-needed relief to the struggling sector. Since July we have seen the house prices more than make up the falls seen earlier in lockdown, and now comfortably sit at record new highs.

However, there are some signs that the housing market is starting to cool. There has been a slowdown in the issuance of Energy Performance Certificate’s, which are a legal requirement to sell a house. Looking ahead, more than 20% of our clients expect a fall of greater than 5% in house prices over the next 12 months; this is in line with our own expectations. The main reason for this is that the stamp duty holiday is due to run out in March next year, which is likely to see a decline in demand for housing. Another contributory factor to our forecasts is the fact that unemployment is going to continue to rise well into 2021, undermining the general confidence in the economy and housing market.

Listen to our podcast on the latest mortgage and house price trends here.


Brexit

We cannot conclude our ‘look-ahead’ without commenting on Brexit. Our central assumption is that the UK will secure a WTO + deal, simply meaning that there will be better terms than a no-deal. However, should a no-deal Brexit occur, it will significantly increase the downside risks to the UK economy. Not only will household be exposed to further economic volatility if there’s no deal, but certain sectors will be more vulnerable than others. Unfortunately, these sectors dovetail almost perfectly with the industries that have already been impacted by the lockdown, meaning there will be very few sectors unscathed in 2021.

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