Sunday, September 27, 2020
A question of confidence as we face a long six months
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

Weeks like the one just gone do not come along too often. For economy watchers, the cancellation of the planned November budget and the scaling back of the comprehensive spending review was big news, as was their replacement by another emergency economic package.

Rishi Sunak’s winter economy plan, which we cover in greater detail elsewhere, was modest, probably costing no more than a few billion pounds compared with the £190bn plus the government has already spent.

The chancellor stuck to his promise of ending the furlough scheme, replacing it with a UK equivalent of Germany’s Kurzarbeit, under which workers employed for at least a third of their normal hours (paid by their employers) will have a third of their remaining hours paid for by the government, and a third by their employer. The maximum monthly cost to the government is just under £698 per employee.

It has drawn both praise and fire but seemed to me to be pretty well-judged, as was the extension of the temporary cut in VAT to 5% for the hospitality sector to the end of March. Involving both the TUC and CBI was politically astute, the former describing it as a “lifeline”, while the employers’ organisation said it will save hundreds of thousands of jobs over the winter.

It should, but it is hard to say how many. The chancellor has left it to employers to determine which are “viable” jobs and is under no illusions that there will, in spite of his efforts, be a substantial rise in unemployment this winter. The chancellor has left incentives to retrain and recruit until later. This was very much a firefighting operation, in response to a Covid-19 second wave that the government did not expect. Only weeks ago, after all, the talk was of autumn tax hikes.

How much unemployment rises depends on several factors. High amng them is the fact that the winter now looks, in economic terms, a lot colder.

I am not the first to say it, but the worst thing about the announcement last week from Boris Johnson, and the warm-up provided by Professor Chris Whitty, the government’s chief medical officer, was not the measures themselves but that they will have to remain in place “for perhaps six months”.

For half a year, unless things turn out a lot better than the scientists fear, not only are these latest restrictions unlikely to be lifted, but stricter measures may be introduced. This was a new and, for the economy, a damaging piece of messaging. When lockdown was introduced on March 23, there was always a hope that it would be lifted.

The prime minister said of the restrictions announced then: “We will look again in three weeks and relax them if the evidence shows we are able to.” It was not false hope; there was a progressive relaxation of the lockdown in subsequent weeks.

This time, no such hope was offered, only the threat of tougher measures. Maybe it would have been false hope; in March there was the warmer weather to look forward to, which offered the hope of naturally suppressing the spread of the disease. But the six-month timeframe was a serious blow, letting the tyres down on an economy that was still not properly motoring. You could almost hear the spirits drop.

What does it do for the recovery? As I have explained before, the path in and out of this recession is easy to describe. The precipitous fall in gross domestic product started around mid-March, even before formal lockdown, as people and businesses started changing their behaviour. It accelerated with lockdown and reached its nadir in April, the month of maximum lockdown.

The recovery since then, tentative in May, stronger in June and July, owed everything to the easing of restrictions and the re-opening of the economy. August should be fine as far as monthly GDP is concerned, helped by the success of the chancellor’s Eat Out to Help Out scheme, which has now given way, oddly, to “go home early to stay safe”.

The economy should also have continued to grow this month, despite the latest announcements, and a small slippage in the “flash” estimate of the closely watched purchasing managers’ index. One reason for September’s growth should be the return of schools. School closures had a big negative effect on measured GDP in the second quarter. I do not want to upset any parents tearing their hair out trying to understand their children’s schoolwork and attempting to teach it but home tutoring does not count towards GDP. Neither does housework.

The factors that helped push GDP down by a record-breaking 20% in the second quarter, including a large fall in measured educational output, will have reversed themselves. We remain on course for a big jump in GDP in the third quarter. By my calculations, GDP at the end of September – the monthly GDP figure for the month – will be around 5% lower than in February, before Covid-19 hit the economy. This would leave a crucial last lap to be completed before the economy got back to where it was before the crisis hit, in GDP if not in employment and how it feels for many businesses.

This is what makes the new restrictions, and the messaging around them, so concerning, and so unfortunately timed. The latest consumer confidence index from GfK, released on Friday, showed a small improvement to a historically still weak -25, continuing its recovery from the April low point. People remained very gloomy about the economy, though less than they were, and slightly more willing to make major purchases. The survey was carried out before the latest announcements.

Another positive sign was from the Recruitment and Employment Confederation (REC), which reported 129,000 new job adverts in the period September 14-20, the highest weekly total since lockdown. Again this came before the new measures.

It is the fourth quarter we have to worry about and, as I say, it is not the measures themselves but their impact on confidence that matters. The new restrictions will reduce monthly GDP by a mere 0.2 percentage points, according to Oxford Economics, but beyond that “are likely to damage sentiment and encourage more consumer caution”.

GfK, which prepares the consumer confidence index, asks of the modest improvement in recent months: “Can this fragile improvement last, or is it about to come to a grinding halt?”

The last lap of recovery to pre-Covid level of GDP has suddenly become more uphill. Robert Wood of Bank of America, having expected some growth in the next two quarters now predicts stagnation.

Capital Economics, warning that “these new restrictions will set back the economic recovery” also predicts a flat fourth quarter. Economists at ING, the bank, think the rot will set in with the October monthly GDP figures, which are likely to show a fall. Further measures, including the two-week “circuit break” which has been talked of, could turn that fall into a large one.

So is it time to give up on the recovery and accept that the economy will limp into next year, still smaller than it was, until there is better news, or a vaccine, or both, in the spring?

That is now becoming the consensus view, though I have not quite given up yet. If the trajectory of new cases and deaths follows anything like the path described by the government’s chief scientific and medical advisers a few days ago, then the next few months do indeed look difficult. We can hope that it is not so bad, though the government did not give us a lot of reason for any such optimism.