Following a decline of 2.2% over the course of Q1, the Office for National Statistics (ONS) estimates that gross domestic product (GDP) fell a whopping 20.4% during Q2.
To put that into context, our economy shrank by no more than 2.1% in any of the five quarters of consecutive decline during the ‘Great Recession’ 2008/09 crisis. Before we even get to Q2, the Q1 2.2% fall during the current crisis is remarkable enough; it’s tied with Q3 in 1979 as the 4th worst decline in modern record.
Needless to say that Q2’s 20.4% contraction occupies the top spot, with Q1 in 1974 in second place at 2.7%. That’s right, hitherto the worst quarterly decline was just 2.7%.
The data set indicates that Q2’s 20.4% decline was rooted in a more severe decline that occurred during the month of April. The ONS estimate reveals that the British economy actually grew during May and June, increasing by 2.4% and 8.7% respectively.
Of course, the record will show that the UK economy was in recession during Q1 and Q2 in 2020 and that it is the worst recession in modern British history. What will be lost is that almost all of the damage was done in a period no longer than 61 days, during March and April. We expect the data to reveal an expanded economy during Q3, bringing an end to the run of consecutive quarterly declines that usually characterise a recession. And we’re not expecting a small increase during Q3, we’re expecting a big one: the biggest on record, in fact. Thus far, the largest quarterly increase occurred during Q1 in 1973 with a jump of 5.0%. We’ve got our sights on ~12.0%, which seems pessimistic compared to NatWest, Morgan Stanley and Bloomberg, who estimate increases of 19.6%, 18.0% and 17.0% respectively. Mind you, we expect they’ll revise those forecasts down in light of August’s poor showing – ONS estimates suggest GDP expanded just 2.1% (versus expectations of 6.4%), despite the government’s efforts to encourage consumers to spend. However, there is a reasonable amount of evidence (such as that provided by Andy Haldane, Chief Economist at the Bank of England, in his speech on 30 September) to suggest that Q3 GDP figures are of limited consequence to long-term investors, even in the short term; at the moment, the UK stock market is barely reacting to economic data. Even with August’s disappointment, the British economy stands 21.7% higher that its April low and 9.2% lower than it’s February high.
We remain relatively optimistic, although not without an appreciation of downside risks – not least the threat posed by rising infection rates and the potential for another nationwide lockdown (or widespread local lockdowns that approximate another national lockdown). Even with a historically high rate of expansion in Q3 and further strong gains in Q4, that incredible period of decline during March and April leaves us still with a sizable hole in GDP for 2020.
August’s weaker-than-expected GDP estimate will likely see the Bank of England add to it’s stockpile of British government bonds and, perhaps, investment grade corporate bonds during the remainder of the year. That will ensure that the government will enjoy negative yields on borrowing (on maturities as far as 6.5 years on today’s process) for a while longer yet. That is one of the reasons we remain reasonably calm in face of government borrowing which, in the UK, has hit £2 trillion for the first time. Eye watering debt levels have been match with bargain basement yields. Indeed, the government can borrow at a cost of 0.2% at the 10 year horizon and, believe it or not, at just 0.7% for debt that doesn’t mature for 40 years.
More Quantitative Easing – perhaps another £100 billion added to the existing £745 billion – or QE is as far as we expect the Bank to go, at least in the short term.
There has been a great deal of speculation about the potential for Bank Rate (often referred to as ‘base rate’) to be driven into negative territory. That is possible, but we think it will only come about if the outlook deteriorates significantly from here. We suspect that there is a majority on the Monetary Policy Committee that remain sceptical of the effectiveness of negative rates as a policy tool.
Even so, conditions would have to deteriorate still further for negative rates to be passed on to savers in high street deposit accounts. Given what we know today, we think it unlikely that savers will see negative rates passed on to them even in the unlikely event that the Bank of England does experiment with policy rates beyond the zero bound.
In our estimations, it remains unlikely that consumer prices will trend higher in the near term. The Bank of England’s most recent assessment reflects their expectations for the year-on-year rate of increase in the Consumer Price Index (CPI) to finish this year around 0.3 before rising gently to close to the 2.0% target by this time next year.
We are conscious that a number of investors remain concerned that today’s stimulus – both fiscal and monetary – might encourage high inflation in the long-run. That is a risk we are alive to and we remain vigilant. Our best guess, at this time, is that inflation remains reasonably well-behaved.