Chief Economist’s Weekly Brief – Race to the bottom

New data and economic forecasts paint a dire picture – prepare for the worst economic downturn since the Great Depression. More countries are gradually lifting restrictions and some 86 candidate vaccines are being developed around the world. But we are still far from a clear exit strategy.

Shuttered. A bleak picture is emerging of how much the business landscape has deteriorated since the UK entered lockdown. In the fortnight to 5 April, an ONS survey reveals that one-quarter of all businesses have temporarily closed. Conditions for businesses that remain open are tough. Most report that turnover has dropped, with 38% experiencing a substantial fall in sales. Firms are unable to shield staff from the pain and, on average, have already furloughed over one-fifth of their workforce. Over 40% plan to cut staffing levels in the short term and 29% are reducing working hours.

OBR’s OMG. Economic forecasting has resembled a race to the bottom, with the latest projections getting progressively worse. Last week was the Office for Budget Responsibility’s turn. Assuming a three-month lockdown, the UK economy would shrink by 35% q/q in Q2 2020 and unemployment would soar to 10%. The budget deficit would hit 14% – its highest level since WWII – requiring an extra £220bn of borrowing relative to last month’s Budget. A strong recovery would quickly come to the rescue in Q3. But take note, this is not a forecast, just a scenario. The forecast remains a work in progress.

Regional variation. The OBR’s “reference scenario” has set economists’ pulses racing. One think-tank, the Centre for Progressive Policy, has applied the same methodology to the 382 Local Government Districts (LGDs). While national economic output could shrink by 35% in Q2, the same scenario could see falls ranging from 18% (Orkney Islands) to 49% (Pendle, North West) across the UK. The North West and Midlands occupy nine of the top 10 most affected LGDs. Mid-Ulster, the manufacturing & construction heartland of Northern Ireland, is the highest ranking in NI (7th) with an expected 45% q/q decline in Q2. Meanwhile Derry City & Strabane, alongside Belfast, are set to be the least affected with a ‘mere’ 30% slump.

Health check. As we await the ‘freak’ declines in Q2, more out-sized falls in activity have emerged for the tail end of Q1. March’s PMI saw Northern Ireland private sector activity fall at a record pace (29.1). Hiring intentions have fallen off the proverbial cliff too. The Jobs Report revealed that job listings plunged by 63% in March relative to February. Hospitality firms have been hit hardest during the lockdown with vacancies down almost 90% m/m. Skills shortages haven’t disappeared altogether. Demand for positions within Nursing, Healthcare and Medical positions remains strong and eclipsed IT for the first time as the top category for job listings. Given the current health emergency, this is perhaps not surprising.

The Great Lockdown. The IMF also issued its new forecast, describing the current situation as a crisis like no other in three critical ways. First, the size of the shock – the output loss will dwarf the financial crisis. Second, severe uncertainty – the duration and intensity of the shock. Third, the different role for policy – calibrating a response to these circumstances is hugely challenging. With those caveats came a forecast of a contraction in global output of 3% this year, blowing past the minus 0.1% estimated for 2009 at the worst of the financial crisis.

Big numbers. No major developed economy is set to escape the clutches of a sharp contraction according to the IMF. The UK is set to see a decline of 6.5%, while the euro area (-7.5%) and the US (-6.1%) are similar. The better news was to be found in the forecast for 2021 with uniform expansions expected. But that depends critically on the pandemic fading in the second half of 2020. With so much uncertainty, considering different scenarios really matters. In the event of a second wave in 2021, the IMF envisages a much sharper decline in activity.

Small numbers. The story is mostly the same in emerging markets. The majority of regions, including Eastern Europe, Latin America and Sub-Sahara Africa are expected to experience declines this year. The exceptions are the behemoths. Both China and India are expected to grow in the 1-2% range. But that’s their ability to recover more quickly after the initial shock. They won’t be spared a sharp economic decline. Last week China revealed the extent of the damage for Q1 with the economy estimated to have contracted 6.8% y/y. The last time it acknowledged a year-on-year fall in output was 1976.

Under the cosh. US retail sales plunged by 8.7% m/m in March, below market expectations. This was the biggest monthly decline on record. Covid-19 containment measures were the main culprit. Witness record declines in restaurants (-26.5% y/y) and clothing (-50.5% y/y). In contrast, non-store retailers eked out a modest rise in sales. Food store sales also increased, aided by precautionary buying. With shutdowns becoming more widespread in the US and layoffs spiking recently, further bad news for US brick and mortar looks likely in April.

Oil is not well. Any hope that the OPEC+ truce would bring respite to the oil market was dispelled very quickly. The International Energy Agency expects the COVID induced demand shock in April to be triple the size of the agreed cut in production. As a result oil has fallen by c. 20% since the OPEC+ deal was announced. The glut is more pronounced in the US, where the WTI benchmark is trading at the lowest levels since 1999. In fact, there have been isolated incidents of inland producers paying to get rid of oil, i.e. a negative oil price!

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