Cumberland Advisors Market Commentary – The UK Economy Falls Off the Cliff; Brexit Negotiations Resume

Author: William Witherell, Ph.D., Post Date: April 24, 2020
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The economic situation in the UK has worsened dramatically in just the month and a half since our March 4th commentary on the subject. Last week, the Bank of England’s (BOE) governor, Andrew Bailey, told journalists that he did not disagree with the Office for Budget Responsibility’s forecast of a 35% decline in the UK’s economy, as measured by GDP, in the second quarter from the start of the year. Furthermore, he warned that the economy could experience long-term harm or “scarring.” The BOE is now developing its own economic projections, which will be released in early May. Current information on the economy is indicating significant drops in the output of many sectors, large rises in claims for credit, and high use of the UK’s furlough scheme for employees.

Market Commentary - Cumberland Advisors - The UK Economy Falls Off the Cliff; Brexit Negotiations Resume

Last week, UK GDP was reported to have fallen 0.1% in February 2020; and over the three months to February, the growth was just 0.1%, with production falling 0.6%. This was the already weak situation leading up to the shutdown of the UK and global economies. Yesterday the preliminary April HIS Market Composite Purchasing Managers Index for the UK was reported as having experienced by far the fastest decline in business activity since comparable figures were first released some two decades ago. The flash April index of 12.9 was far below 50, the reading that indicates no change in the level of activity. Indeed, 81 % of firms in the service sector and 75 % of manufacturing firms reported lower levels of activity in April. Job losses have occurred on an unprecedented scale. A poll undertaken between April 1 and 3 by the British Chambers of Commerce indicated that 57% of respondents intended to furlough more than three-quarters of their staff in the near future. The Enterprise Research Center released another striking statistic: “Some 21,000 more UK businesses collapsed in March than in the same month a year ago.” The deterioration in the UK economy continues to worsen.

The government has extended its virus-containing lockdown, now in its fourth week, to May 7th. The UK prime minister, Boris Johnson, who is still at home recovering from Covid-19, warns wisely that “Any second surge in the virus will do the most damage to health and the economy.” Johnson’s cabinet is reported to be split, with some arguing for a swifter economic reopening and others agreeing with the prime minister and Matt Hancock, the health secretary, that early lifting of restrictions is too risky. Rishi Sunak, chancellor, has ordered Treasury to model for a U-shaped recovery. There are fears that unemployed workers will not quickly find new jobs.

The government has fine-tuned its job-retention and small business loan schemes and is expected to add further support for small businesses and households soon. The BOE recently increased its Ways and Means Facility to provide the government greater cash flow flexibility. Last month the BOE cut interest rates and announced the latest and largest round of quantitative easing as well as a scheme for banks, designed to encourage them to continue lending to companies.

The UK’s epidemic may have peaked, but the difficult battle is far from over. As of April 20, the number of cases in the UK was 120,067, compared with 145,742 cases in Germany. However, Germany had experienced only 4,642 deaths, whereas UK deaths numbered 16,060. The Financial Times this week published a very disturbing estimate that the virus caused as many as 41,000 deaths. The official figure only counts those that have died in hospitals after having tested positive. Germany’s relative success is due to comprehensive testing, rapid moves to protect vulnerable people, and the willingness of German citizens to adhere to strict contact curbs. The UK by April 19th had the highest number of daily deaths outside of the US, according to the Financial Times. The country is unfortunately paying for its slow start in addressing the virus.

This week, the UK and EU Brexit negotiators are scheduled to meet via video conferencing in an attempt to salvage negotiations on the future relationship of the United Kingdom and Europe, following the UK’s departure from the European Union. These talks have been disrupted by the pandemic and will be restarting in a dramatically different economic environment and outlook. The virus has had a direct effect on the process, as Michel Barnier, the EU’s chief negotiator, tested positive for Covid-19 in mid-March; and shortly thereafter, David Frost, the UK’s chief negotiator, displayed symptoms and went into self-isolation. The previous schedule had called for three full negotiating rounds to be completed by this date. Instead, the limited contacts have not resulted in any closing of the wide differences between the two parties.

The exit treaty agreed last year includes the possibility of extending the transition period for up to two years after the end of the current year. Pressure is mounting for extending the period in view of the time that has been lost and the changes in the outlook for both the UK and Europe, including the heavy damage that the shutdowns have dealt to the private sector. Yet the UK government continues to insist on the end-of-2020 deadline, despite the limited time remaining to negotiate a new trade agreement. Johnson maintains he is willing to see the UK exit the EU at the end of the year without an agreement (a “hard Brexit”). That would mean the UK’s having to adopt the much less favorable WTO terms for its trade and a hard regulatory border between the UK and the EU, with customs and regulatory procedures. It is estimated that, as a result, trade with the EU over the next ten years would be reduced by some 40%, impacting future investment and productivity growth. That prospect may convince the government to eventually concede to an extension of the transition period.

Aside from the Brexit uncertainty, the outlook for the UK economy is for a deep and likely extended recession. The IMF in its April Economic Outlook projected UK economic growth in the current year to be -6.5%, followed by a modest pickup in 2021, +4.0%. The IMF emphasizes that there is “extreme uncertainty” about economic growth forecasts being made at this time. We agree, but we find the downside risks for the UK economy to be very worrying.

Bill Witherell, Ph.D.
Chief Global Economist & Portfolio Manager
Email | Bio


Sources: Financial Times, BBC.com, HIS Markit, BBH Currency Strategy, International Monetary Fund, Goldman Sachs, Barclays


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