INSIGHTS

The UK economy rebounded strongly during the summer months, helped by significant support from fiscal and monetary policies and a gradual return to normal life after lockdown. However, the recent surge of COVID-19 cases and subsequent imposition of partial lockdown conditions are a major setback to the UK economy.

Summer’s lease hath all too short a date

As the UK heads into winter the strong second wave of COVID-19 cases and the consequent new lockdown restrictions threatens to push the UK economy into reverse. Perversely, the increased economic uncertainty will likely create a ‘bad news is good news cycle’, meaning that bad news on the economic front can be good news for financial markets because it will result in both ongoing monetary stimulus and government spending aimed at saving jobs, supporting income and protecting businesses.

This setback means that the next stage in the UK economic recovery will be delayed and possibly slower than previously thought. The longer restrictions are placed on economic activity the greater the risk that jobs and businesses are lost permanently. Hence the Government and central bank have no real choice but to continue to do what they can to nurse the economy along and ensure it is in the best possible shape as it exits the crisis.

A tough few months

The UK Government’s furlough scheme which has been key in supporting the labour market so far is gradually being wound down. Further measures to protect jobs and incomes are likely but the support cannot continue indefinitely. The full fallout from COVID-19 won’t be apparent until some degree of ‘new normal’ is reached but the unemployment rate will be significantly higher than it was pre COVID-19. A recent survey from the Lloyds Business Barometer suggests only 20% of firms who furloughed staff expect to retain all of them. This is a potential concern as consumption, which is heavily impacted by incomes, will be an important factor in the economy’s recovery.

Low interest rates are expected to continue

Monetary policy is expected to remain very accommodative for the near future. Quantitative easing and low interest rates are its key tools to keep the economy trucking along. The Bank of England’s is likely to respond to the economic setback with further quantitative easing to help support the economy. They also have not ruled out negative interest rates, but for now that doesn’t appear to be the preferred approach.

Fiscal policy continues to play an important part in protecting jobs and businesses as ‘wage support’ puts money in the pockets of consumers. However, fiscal support is not limitless and will eventually be wound down and the speed and scale of the withdrawal will have some impact on the strength of the economy over the next year or two. It is highly likely that more targeted measures will be required for parts of the economy hit hardest by the pandemic such as hospitality and entertainment.

Brexit uncertainty remains

Brexit remains a source of uncertainty for businesses and the share market. It does appear that the gap between the UK and the EU has narrowed and the rhetoric around cooperation has increased. However, there is still no resolution, and this remains a headwind to business confidence and investment.

A no-deal Brexit will hurt the recoveries for both the UK and EU, affecting business confidence, and it may slow growth due to lower employment and trade disruptions. This could hamper both importers and exporters as the longer-term inflationary implications that could arise from higher tariffs and a shortage of goods. A no-deal Brexit would likely be negative for the sterling as well.

What effect will this have on NZ?

The recent setback to the recovery in the UK economy compounded by ongoing uncertainty of a no-deal Brexit could be problematic for UK financial markets. From a long-term perspective, the sterling looks under-valued but failure to reach a trade deal with the EU will likely lead to a weaker sterling. For New Zealand, trade with the UK represents 3% of exports but the UK will be keen to strike trade deals with as many countries as possible and this could bode well for NZ, particularly in areas of primary produce exports.

For those with investments in the UK

For New Zealand investors, and those many New Zealanders or UK expats who still have pension fundsor UK investments, financial markets generally hate uncertainty, so while the UK equity markets and the currency may appear on cheap side, while uncertainty around Brexit exists it is unlikely they will outperform.