Weekly Market Commentary: 15 July 2020
In this weekly update, we’re going to focus on the UK economy following the latest data released by the Office for Budget Responsibility (OBR) this week. As a reminder, the OBR is a non-departmental public body funded by the UK Treasury, that the UK government established to provide independent economic forecasts and independent analysis of the public finances. It was formally created in May 2010 following the general election.
Let’s start with the outlook for economic growth. The sharp fall in output between the fourth quarter of 2019 and the second of 2020 is now estimated to be 23% and is mainly the result of mandated and voluntary restrictions on business activity, while the temporary furloughing of employees has been heavily subsidised via the Coronavirus Job Retention Scheme (CJRS).
Whilst the first quarter is expected to be painful, in both the positive and negative scenarios this is expected to be the low and economic growth is set to improve. There are already signs of this coming through with the economy grew by 1.8% in May. In their best case the economy can get back to pre-Coronavirus economic output levels in early 2021; the OBR worst-case suggests that it could take 4 to 5 years. The reality is these are both extremes and the expectation and central scenario is the economy will be back at pre-crisis size at the end of 2022.
Let’s now take a look at debt levels in the UK. The speed and quantity of the government financial support to the economy during this time have been significant. However, these packages need to be paid for and it’s being funded by debt. The increase in borrowing this year is expected to be between 13 and 21% of Gross Domestic Product (GDP), lifting debt above 100% of GDP in all but the positive scenario.
As the economy recovers, the budget deficit is expected to fall back. Public debt is increasing but it has been higher historically during both World War I, the subsequent 1918 flu pandemic and World War II. At some point this debt will have to be paid back from a combination of both tax rises or spending cuts. If this wasn’t done then the UK debt would start to dwarf the size of the economy, growing to more than 400% of GDP in 50 years’ time.
Impact of Coronavirus
In summary, the impact of the Coronavirus on the economy is significant both from economic growth and a debt perspective. The OBR believes the economy is currently at a low and set to recover – and the May GDP growth suggests this is the case as the UK emerges from lockdown. In their central scenario, the UK economy will be back to where it was in two years’ time.
The economic impact would have been significantly worse without the support from the government and this will see debt levels increase to the higher levels in 60 years. However, debt levels (as a % of GDP) have been higher than this historically and will be brought down as the economy recovers and will have to be brought down in the future from a combination of tax rises and spending cuts.
Chief Investment Officer – Luna Investment Management