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Data published this morning showed that the UK economy contracted by 2.0% in Q1. The UK publishes its quarterly GDP data relatively late in the cycle — after the US, the euro area and several emerging economies. Nevertheless, it also includes a detailed monthly breakdown, which gives some indication of how the lockdown, which took full effect on 23 March, has affected different sectors of the economy. The monthly figures show a 5.8% contraction across the economy as a whole in March, with output falling in all broad sectors. Looking across the detailed sub-indices, only public administration and defence saw output rise, by just 0.1%. The ONS also reports gains in both IT support, and the manufacturing of cleaning products.
Looking across the major economies, the hit to GDP in the first quarter has, on balance, been a little smaller than we had expected — and the UK is no exception in this regard. It is almost inevitable that revisions to the initial estimate of GDP in 2020 Q1 will, for many countries, be much larger than usual. And with only one or two exceptions, the most severe lockdowns were not imposed until very late in the quarter, suggesting that most of the impact will not be apparent until we have data for Q2. Nevertheless, there may be some information in the entirety of the Q1 estimates published to date. Over the next week or two, as more data become available, we shall review our estimates of the initial hit to global economic activity from COVID-19.
Yesterday, UK chancellor Rishi Sunak announced that the UK Coronavirus Job Retention Scheme, which allows businesses to furlough most staff, and see up to 80% of their wages paid by the state, would be extended until October. The terms would remain unchanged until August, though it is likely that, during the period from August through to October, employers would be expected to make a contribution. We have previously argued that substantial fiscal support packages, in most cases of the order of at least 15% of annual GDP, would be necessary if countries were to benefit from a sharp rebound in economic activity once the worst of the pandemic is behind us. In that respect, the four-month extension of the UK scheme, on more generous terms than expected, is to be welcomed.
Fiscal support packages are a necessary, but not sufficient, condition to deliver a V-shaped recovery across countries. Public confidence will also be key. In order for an economy to return gradually to more normal levels of activity, firms and households will need to be confident either that the threat from the virus has been contained once and for all, or, more plausibly, that the government can be relied upon to bring it quickly back under control should there be a second wave. And in this regard, it is clear that the performance, and the strategies, of governments around the world have varied enormously. South Korea, Australia and New Zealand all have clearly defined peaks in the number of new COVID-19 cases. The measures they took varied, with South Korea relying more on test-track-trace, while Australia and New Zealand resorted to early and aggressive lockdowns. Nevertheless, the success of these countries in dealing with the first wave is likely to give residents greater confidence as the economies start to reopen. At the other end of the spectrum are countries like the UK, the US and Sweden. These countries have much less well-defined peaks in the number of new cases, which may in part reflect changes over time in testing strategies.
We continue to be surprised not just at the relatively modest reaction of global equity markets to the pandemic, with the S&P 500 now down just 15% from its peak, but by the ways in which investors have differentiated, or failed to differentiate between countries. Consumer discretionary stocks, which ought to be a good indicator of investor beliefs regarding the pace of the recovery in different countries, have fared much better in the US than elsewhere. US consumer discretionary stocks are now down just 5% year to date.
Fathom forecast scenarios
Economic forecasting is difficult even at the best of times. It is particularly difficult today. At Fathom, we think in terms of scenarios and seek, wherever possible, to downplay point forecasts. A severe contraction in global economic activity through the first half of this year is inevitable – we are facing what French economist Pierre-Olivier Gourinchas has referred to as a ‘sudden stop’, something the global economy has never experienced before. But how long will it last? In our Global Economic and Markets Outlook for 2020 Q1, we set out three scenarios. The first was a V-shaped recovery, in which the number of cases peaks within months and begins to decline, allowing activity by the end of this year to return to normal levels. The second was a U-shaped recovery, where the virus continues to spread, depressing activity until a vaccine is found, but the economic and financial market infrastructure remains in place to deliver a strong rebound when that occurs. The third was an L-shaped recovery. Since we finalised our forecast on 17 March, a number of major economies have placed more severe restrictions on movement, and imposed a temporary shutdown on more industries than we had thought likely. This more aggressive action has caused us not only to anticipate an even sharper contraction in economic activity in the first few months of this year, but to increase the weight we attach to a V-shaped recovery. At the same time, we have also increased the weight we attach to our more severe risk scenario, making the outlook somewhat bimodal. In the event that COVID-19 returns with equal or greater vigour once restrictions that are holding back economic activity are lifted, then a severe financial crisis will be very hard to avoid.
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