Record GDP contraction forecast for Q2 2020, but economic recovery in sight for next year, says EY

Stuart Wilkinson

The EY ITEM Club has further downgraded its GDP forecast for the UK economy this year and is now predicting an 8% contraction for 2020 compared to the 6.8% fall it predicted in April.

Since the release of its Spring Forecast 2020 in late April, the EY ITEM Club has also downgraded its Q2 2020 forecast from a 13% contraction to a record 15%. The gloomier forecast figures reflect a poor economic performance in April due to the lockdown and deeper than expected contraction in Q1 (a 2.0% quarter-on-quarter decline, greater than the expected 1.3% q/q contraction).

Positively, the EY ITEM Club now predicts year-on-year GDP growth of 5.6% in 2021, up from the 4.5% expected in its previous forecast. The report warns, however, that the UK economy is still not expected to return to its Q4 2019 size until early 2023.

Today’s report is the EY ITEM Club’s first ever interim report between two quarterly updates. This is due to the rapidly changing economic environment and uncertainties ahead.

Howard Archer, chief economic advisor to the EY ITEM Club, says: “The impact of COVID-19 on the UK economy will depend on just how long the pandemic lasts, how many people are affected and how long restrictions to activity have to be in place. The hope is that while there will undoubtedly be a substantial impact on the economy, it will be restricted in terms of time and there will be limited longer-term repercussions.

“The UK economy had been disappointingly lacklustre over the first two months of 2020, even before COVID-19 started to become a factor. After a challenging first half, our forecast shows that the UK economy is expected to start to recover in Q3 2020 on the assumption that the Government continues to gradually relax lockdown restrictions.

“The substantial fiscal and monetary stimulus that has been enacted by HM Treasury and the Bank of England should provide serious support to activity as coronavirus cases wane and life returns to the new normal. Global economic activity should also be significantly stronger from the latter months of 2020 onwards as other economies start to recover.”

Consumer spending concerns

The EY ITEM Club report says that consumer spending could contract by 17% q/q in Q2 2020 and by 8.7% over the whole of the year, before recovering by 5.0% in 2021 as lockdown restrictions continue to be eased. A key factor in consumer spending will be the labour market, and the EY ITEM Club says that it is unlikely the job losses suffered in 2020 will be fully recovered for some considerable time to come.

Howard Archer adds: “Many people have lost their jobs despite the Government’s supportive measures and we’re currently expecting the unemployment rate to increase to around 7.5% in Q3 2020 from 3.9% in the months to March. This will inevitably have some limiting effect on the economy’s recovery.

“Positively though, consumer purchasing power should also benefit from very low inflation, and we believe consumer price inflation could fall as low as 0.2% over the summer. There is likely to be a fair degree of pent-up consumer demand, too.”

Fiscal support for the economy

The EY ITEM Club report also predicts that, in the near term, further help for the economy is likely to come from the Bank of England in June through an additional £100bn in asset purchases, taking the stock up to £745bn. The EY ITEM Club says it’s unlikely that the Bank will lower interest rates further from the current 0.10%, although notes that the Bank is actively reviewing the case for negative interest rates, having long considered they were not suited to the UK.

The fiscal support that the Government is providing for the economy, businesses and jobs means the budget deficit (measured in terms of Public Sector Net Borrowing, excluding banks (PSNBex)) is likely to be at least £320bn (15.6% of GDP) in 2020-21. PSNBex was at a record monthly £62.1bn in April, which was the first month of fiscal year 2020-21. To put this into perspective, the Office for Budget Responsibility (OBR) had forecast a total PSNBex for 2020-21 of £54.8bn in the March Budget.

Business investment

The report predicts that total investment will fall 13.7% in 2020, with business investment declining 14.0%. This will be partially offset by an expected 4.8% increase in government investment. Additionally, government spending is forecast to rise 4.5%. Net trade is expected to make a negative contribution of 0.2 percentage points to GDP this year as exports of goods and services fall by 11.4% while imports decline by a lesser 10.6%.

Looking ahead to 2021, government investment is expected to increase 12.9%, contributing to overall investment growth of 3.9%. Business investment is expected to rise by 1.4% y/y in 2021 as companies recover from the impact of COVID-19. However, this modest overall growth rate for 2021 masks a significant pick-up in business investment during the year with the year-on-year change improving from -17.2% in Q1 2021 to 13.7% in Q4 2021. 

Long-term scenario planning is key for businesses says EY

Stuart Wilkinson, Office Managing Partner at EY in the East of England (pictured), comments: “This is an undoubtedly challenging environment for businesses and forecasting is extremely difficult, particularly with different countries and sectors recovering at different rates as lockdown restrictions are eased. With this interim forecast, there are some significant adjustments to our GDP expectations compared to what the data told us just six weeks ago.

“The East of England has a varied economy, known as much for its strength in pharma-industries as it is for its agricultural landscape. Businesses in the region operating in food manufacture, processing and production have faced different types of challenges as a result of the COVID-19 pandemic, including managing their supply chains and for some  increasing  their required workforce, alongside restrictions. Technology has played an important role in supporting these businesses during this time, and it is likely to play an ever-increasing part as they evolve in the next 6-12 months.  

“Businesses will not only need to respond to the short-term impact of COVID-19, but also the long-term shifts in the economy, accelerated by the pandemic. The ‘new normal’ will be different to what’s gone before, and with so much government support in the economy, it will also be important for the private sector to align itself with government initiatives.”

Downside risks to the forecast

The EY ITEM Club warns about a number of downside risks to the outlook. This included the possibility of a significant new coronavirus wave occurring later in the year, and the potential of prolonged consumer caution, even after the Government lifts lockdown restrictions.

Separately, recent data from EY’s Future Consumer Index shows that British people are concerned about returning to “normal life”, with 72% of UK consumers saying they would not feel comfortable going shopping at all, for example.

The threat of longer-term damage to the economy from business closures and uncertainty over the outcome of talks between the UK and EU on the post-Brexit trading relationship, are also listed as potential downside risks.

Concluding, Howard Archer adds: “Until a trade deal is agreed between the UK and EU, there is likely to be uncertainty for many businesses as the end of the current transition period approaches in December. The assumption is that there will be some sort of deal to replace the transition arrangements, but further adjustments to the forecasts may be needed in a ‘no deal’ scenario.”

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