UK in recession as services exposure, Covid missteps weigh – shares fall

The UK is officially in recession – its severest since quarterly series records began to be compiled in 1955.

UK gross domestic product (GDP) shrank by 20.4% in the second quarter, according to data released yesterday. That compares with a first quarter drop of 2.2%.

Those figures come on the back of encouraging June data showing a month-on-month climb back for output of 8.7%, beating many analysts’ expectations.

A recession is generally defined as two consecutive quarters of negative growth.

Because of the heavy services bias of the UK economy, where manufacturing plays a smaller role than in the US and Germany, the impact of the Covid-induced economic downturn has been more severe.

Chancellor Rishi Sunak told the BBC that the government is “grappling with something that is unprecedented”.

UK has worst GDP in Europe

The length of the UK lockdown has also taken its toll. The UK downturn is now officially the worst in Europe.

The UK’s 20% plunge in economic activity compares with a 11.9% fall in Germany, for example, and 10.6% in the US.

Taking the monthly output data into account, which saw a strong 8.7% bounce in June,  UK economic activity is still 17% below where it was before the lockdown in February.

The services sector accounts for three quarters of the fall in output. In addition to financial services one of the largest sub-sectors of services is leisure and hospitality, both areas that are likely to be the slowest to recover.

Sectors such as construction did particularly badly, but that is perhaps partially explains why the sector has seen one of the strongest recoveries.

Oil companies are an important of the UK economy and the fall in demand for the black stuff has hurt the profitability of firms such as BP and Royal Dutch Shell, not to mention the generous dividends they had been accustomed to paying their shareholders.

Household expenditure and business investment

There have also been record falls in household expenditure. Even more worrying perhaps is the possibility that the collapse in business investment – down 31% – could be a particular laggard in rediscovering former vigour. Without investment the future growth that recovery  entails is harder to come by.

If the June output figures shows through in continuing improvement in July , then companies will be more likely to reconsider signing off on previous investment plans.

However, if the good news contained in the June bounce finds the economy emerging from the summer to face a second wave of Covid infections, it will underline the lengthy prognosis for recovery as an immanent fear.

And with unemployment set to rise to levels not seen since the 1980s, it is another vector for sucking demand out of the system.

The level of unemployment also impacts those in work. On the one hand it may have increased productivity during lockdown (fear of those in work losing their jobs)  while on the other the unemployment pall will weigh over consumer sentiment, making employed consumers more likely to hold back on big-ticket purchasers.

Can the housing market avoid a bust?

Housing is another important element in terms of how consumer feel about spending. The UK property market has in fact held up surprisingly well, apart from in the commercial sector where office space and retail are both surely seeing re-ratings of values.

In the past month, house prices have risen across the country – with the exception of London. This has been driven in large part by the cut in stamp duty paid by buyers. The threshold before buyers pay the tax has been lifted to £500,000. That had less impact in London where the average house price is much higher than in the rest of the UK.

But market watchers are being warned that the current rosey outlook for house property might not last.

The Royal Institute of Chartered Surveyors’ chief economist Simon Rubinsohn sees possible trouble ahead, with boom turning to bust.

“There remains rather more caution about the medium-term outlook with the macro environment, job losses and the ending or tapering of government support measures for the sector expected to take their toll.”

Rubinsohn continued: “Significantly, some contributors are now even referencing the possibility of a boom followed by a bust.”

If the housing market slams on the breaks and, and an even worse scenario comes to pass in which prices start to fall, that will have an outsized detrimental impact on consumers’ willingness to loosen the purse strings.

Will money printing = inflation?

Another worry on the macro side is rising prices. Thankfully, though, despite the continued unconventional monetary policies of central bankers, there are still no signs of inflation building up inside the system. The last time the central banks opened up the money taps in 2008-9 there were fears of inflation that never materialised.

This time could be different as the governments have joined in the central bankers money-printing with a spending spree of their own, with massive fiscal expansion.

There is no-one just yet talking about the UK not being able to afford its borrowing to pay for the Covid mess, but that might not always be the case.

The UK faces some special risks, and they are related to Brexit and the looming end of the transition period in January 2021. If the UK fails to secure a deal that protects the City of London’s preeminent position as the premier European financial centre, that could be potentially crippling for UK plc.

Bank of England dovish stance

Although the Bank of England has made no indication that it will be changing its dovish stance on monetary policy, rates on government debt may start to tick higher and the pound weakens further against other major traded currencies.

However, a weak pound is good for many FTSE 100 constituents that book earnings in dollars. But a cheaper currency means more expensive imports, and that could feed into generally higher prices. But those are really worries for another day as we are not there yet on Brexit.

Investors must nevertheless contend with the possibility – or likelihood – that the UK leaves the EU without a trade deal and the uncertainties that brings, the closer we get to year-end.

The FTSE 100 is 1.3% lower today after a storming Wednesday, that witnessed a 2% leap in the value of the index. More sober minds may be on the tillers today, with prices paring yesterday’s gains.