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UK recession: Where do we go from here?

Date: 25 August 2020

UK: Suitable for retail and professional clients
Singapore: For sophisticated investors only

 

Figures from the UK’s Office for National Statistics (ONS) revealed the UK economy contracted by more than 20% in the second quarter of 2020, officially bringing the UK into its first recession in more than a decade. Hinesh Patel, portfolio manager at Quilter Investors, looks at what these figures mean and where we go from here.

The confirmation that UK gross domestic product (GDP) – a measure of economic activity - fell 20.4% between April and June 2020, compared with the first three months of the year, triggered a slew of headlines as the UK entered its largest recession in history.

A recession is where a country or region experiences a decline in economic activity. In the UK there needs to be two consecutive quarters, or six months in total, of negative economic growth for it to be defined as a recession. Recessions are often triggered by changes in fiscal and monetary policy or by various large-scale shocks such as a financial crisis or, in the case of the current recession, a global coronavirus pandemic.

While a recession has been expected since the UK, and most other global economies, went into lockdown in March, the scale of the figures may have taken some by surprise, given the first quarter contraction was a much smaller -2.2%. In addition to this being the first UK recession since the Global Financial Crisis of 2008/09, the ONS pointed out the second quarter contraction was the largest since records began in 1955, reflecting the “ongoing public health restrictions and forms of voluntary social distancing that have been put in place in response to the coronavirus pandemic”.

 

Impact of a recession

Often when a recession occurs both business and households look to tighten their belts. This allows them to prepare for any future unexpected shocks during and post the difficult period. This means aggregate spending will fall and saving rates will rise.

Unfortunately, it does usually mean jobs will be lost as businesses look to reshape how they operate in a more challenging environment, and look to save costs, either through reducing the workforce or pausing wage increases. Certain sectors may be hit particularly hard with the double shock of a recession and the ongoing coronavirus pandemic, with services and manufacturing, particularly hospitality, airlines and construction, all already feeling deep wounds of the mandated lockdown.

As companies look to reduce their overheads, this subsequently has a knock-on effect with the amount of tax collected by the government dropping. First, as people are made unemployed or wages and hours worked are curtailed and second through households’ increasing precautionary savings.

Traditionally, the government would provide a double espresso to get the economy going and then later make cutbacks, as we saw following the financial crisis over a decade ago with the introduction of ‘austerity’ measures to balance the books.

However, this isn’t like any recession the UK (or world) has experienced in living memory. This health crisis has redefined the lexicon for “recession” with its speed and magnitude of contraction – and one where the role of government remains critical to reduce collateral damage. Most important, it is propping up the employment market with the job retention scheme, so the true effects of this recession may not be seen until government support, such as the furlough scheme, is fully withdrawn in the quarters and years ahead.

Most important, it is propping up the employment market with the job retention scheme, so the true effects of this recession may not be seen until government support, such as the furlough scheme, is fully withdrawn in the quarters and years ahead.

Businesses remain nervous about expansion and employment and households are unwilling to spend their savings until more (economic) certainty emerges, so the government needs to pick up the slack. The government is actively trying to encourage people to spend money and support their local businesses or take holidays within the UK. Areas such as house purchases with temporary stamp duty changes and the (re)introduction of grants for environmentally friendly home improvements are helping large-ticket purchases, whilst innovative actions such as the “Eat Out to Help Out” scheme are (temporarily) helping high streets return to a semblance of normalcy.

 

Next steps

Undoubtably it will take a considerable amount of time and effort for the economy to heal. The long, slow road to recovery is underway and the economy is likely to look very different in the next decade. In general, firms that went into the shock with robust balance sheets and a focus on innovation are taking market share and better weathering the storm. Meanwhile, the somewhat “traditional” businesses of the last decade are having to play catch-up to survive or face demise – supercharging the trends of the noughties.

With economic output at a fraction of where it was in February, further stimulus may be required. The UK relies heavily on the services sector and predominantly consumer consumption. Reversing households’ precautionary savings and providing businesses with confidence and support to spend capital and hire employees will be key.

While the overall picture is shocking, the Bank of England has left itself room to act from a monetary perspective. This shifts eyes onto Chancellor of the Exchequer, Rishi Sunak, to see if his innovations can be successful. The ‘Eat Out to Help Out’ scheme that is scheduled to run throughout August, appears to have gotten off to a good start, and it is this more targeted stimuli that other industries will be craving.

The UK public loves a deal, so this scheme may provide a template for future targeted stimulus. The house builders in particular will be watching it closely, particularly given the proposed relaxation in planning laws.

Business investment and growth in the UK is likely to remain subdued for some time yet, but opportunities still do exist for investors. In such a harshly competitive environment we expect to see quality companies, and those that are more innovative and flexible, likely to prosper. If you combine this with the further stimulus that is expected in the autumn at the Budget announcement, then these types of companies may be the ones to benefit most. All together we are seeing a case of “survival of the fittest” across the UK economy.

Important information

This communication is issued by Quilter plc, registered in England and Wales. For information about our regulatory authorisation details, visit our website at quilter.com. Investors should remember that the value of investments, and the income from them, can go down as well as up and that past performance is no guarantee of future returns. You may not recover what you invest.