Mike Pyle, Global Chief Investment Strategist together with Elga Bartsch, Head of Macro Research, Vivek Paul, Senior Portfolio Strategist, and Nicholas Fawcett, Vice President all part of the BlackRock Investment Institute, share their insights on global economy, markets and geopolitics. Their views are theirs alone and are not intended to be construed as investment advice.
We zero in on the UK this week to highlight the three main signposts we use to assess the impact of the coronavirus: the pace of the economic restart, the state of policy support and evidence of permanent economic damage. The UK’s experience confirms our assessment that the cumulative virus impact will ultimately be a fraction of that of the 2008 financial crisis, but it also shows the challenges ahead.
The UK has been one of the hardest hit developed economies in the Covid-19 pandemic. GDP fell nearly 22% in the first half of 2020, a much bigger shock than other developed countries. See the chart above. Part of this reflects a relatively high concentration of services in the UK’s overall economic activity. The other reason is that the UK lockdown started later but lasted longer than in other European countries as infection rates were slower to drop in the UK. That said, as we previously set out in our framework for assessing the Covid-19 macro shock, financial markets should be focused on the cumulative shortfall in GDP versus its trend, rather than the initial drop in output. On that score, consensus forecasts suggest the UK’s cumulative GDP loss over coming years will be well below that seen in the wake of the global financial crisis. As in other regions, this is thanks to the timely and overwhelming initial policy response. The same holds true for Europe, and especially the U.S.– where we see the cumulative hit as smaller.
The economic restart is under way in the UK. Google data point to mobility roughly 30% below pre-pandemic levels, versus 70% at the trough. This recovery has been somewhat softer than that seen in the euro area and U.S. We believe the recent resurgence in infections – in the UK and many parts of Europe – should not be classed as a second wave, as it partly reflects materially higher testing rates than at the earlier peak of the pandemic. Our assessment also reflects a UK government that is acting preemptively now – especially after criticisms of its late introduction of the initial lockdown and despite weakening political support for reintroducing lockdowns. Future pauses or delays to the activity restart are likely to be materially less significant to the overall economy, we believe.
How about policy support? The UK saw an early policy revolution with a comprehensive and coordinated fiscal and monetary easing with the aim of bridging the gap in private sector incomes. The government’s furlough program saw the state cover most of the costs of keeping workers on payrolls in affected industries. This has kept the unemployment rate low. The Bank of England unveiled a broad package of easing measures and in August added negative interest rates to its policy toolbox –but is unlikely to cut rates below zero in the near term. Weaker data could well be met with further asset purchases.
The risk? Unemployment is set to rise as the UK’s furlough program winds down and is replaced by a more limited program that supports “viable” jobs and companies legally forced to close to stop the virus spread. This highlights the balancing act facing some governments, weighing the desire to provide an income bridge against the cost of impeding reallocation of resources away from nonviable firms in a post-Covid world. Fading policy support is also a key risk in the United States, where talks over additional fiscal support face a narrow and steep path ahead of the November election.
One key challenge looms that could affect the UK economy’s long-term health: negotiating a post-Brexit trade deal with the EU. Tensions increased after the UK floated rules that appeared at odds with a previous agreements, but we still believe that there will ultimately be some form of “skinny” trade agreement. The potential downside for the UK is greater than Europe, which has galvanized its policy response to the crisis by starting a pan European Recovery fund. Overall, our UK assessment offers a window into how we view other regions and markets. This points to potential for a more cautious view on Europe than we currently hold – and a more optimistic one on emerging markets.
COVID infections have picked up in Europe and parts of the U.S., but fatalities are far off peaks reached in the spring. Democratic presidential nominee Joe Biden has widened his lead in polls ahead of the Nov. 3 election, but the race for the Senate looks closer. Talks over a U.S. fiscal stimulus package continued in fits and starts, but the path to a pre-election deal is narrow. This raises the risk of permanent economic scarring and a weakening of an activity restart that has been running ahead of expectations. The U.S. election could change this, as differences in fiscal impulses between the outcomes are large.
Market attention will turn to key data releases gauging the status of the economic recovery across the world. In the U.S. and Europe, we’ll get more color on economic sentiment, especially in areas where virus infection rates continue to pick up. The annual IMF meetings will also be in focus, with growth forecasts likely to be revised up from earlier more bearish projections.
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