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What type of economic recovery could we see in the UK?

Joseph Hill looks at how the UK economy has been affected so far this year and what type of economic recovery we could see as we begin to emerge from months of lockdown.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Joseph Hill
Investment Analyst

Published on 5 June 2020

This article is more than 6 months old

It was correct at the time of publishing. Our views and any references to tax, investment and pension rules may have changed since then.

We’ve heard a lot about different shaped recoveries over the last few weeks and months. Will it be U shaped? Will it be V shaped? Or will it even be W shaped?

The only part that’s certain for now is the first bit of the shape. Unsurprisingly, we’ve seen a big fall in economic activity and the figures are pretty grim. In the first three months of this year GDP (the total market value of all goods and services produced annually within a country) fell by 2%.

This is the sharpest quarterly fall since the peak of the global financial crisis in the latter part of 2008, despite the lockdown only starting in late March. And while it’s too early to assess the second quarter to June, a forecast from the Office for Budget Responsibility have predicted a 35% drop in GDP over this period. But as some sectors have been more affected than others by the restrictions, the impact hasn’t been spread evenly.

Which sectors have been hit the hardest?

It’s clear that Covid-19 has had an impact on almost every area of the economy, causing a record monthly drop in growth in March. You can see in the bar chart below how each subsector of the economy has fared.

GDP growth rates by sub-sector from January - March

Scroll across to see the full chart.

Source: Office for National Statistics, January-March 2020

The service sector, which makes up 80% of the UK economy, has suffered. The closure of non-essential retail outlets, the sharp drop in the demand for travel, accommodation and motor vehicle services have all contributed to a record 1.9% fall.

In other areas, like production the picture hasn’t been bright either. The main cause for the decrease here has been the reduction in the manufacturing of transport equipment driven by the shutdown of car plants across the UK.

Perhaps unsurprisingly, it’s been a similar story in the construction industry with a fall of 2.6%. Social distancing rules made it tricky for lots of companies to operate as we saw a fall in the building of new homes, repairs and maintenance.

But despite the tough conditions for most across the country, some industries have fared better. IT Support, computer programming and consultancy services posted positive figures for the period as those able to do so have transitioned to working from home.

What’s the government doing to help?

In times of recession, which looks very likely, companies are often dealing with lower demand for their goods and services. Meaning they can be under pressure to baton down the hatches and cut costs.

We’ve seen this on a much greater scale recently. Rather than see a dip in demand like in a normal recession, some businesses have had to deal with complete evaporation of demand and no revenue at all. And for many companies one of their largest costs is their wage bill and paying their staff. Unfortunately, this often means redundancies and increasing unemployment.

This is something that the UK government have looked to help avoid though through the job retention scheme. The scheme’s part of a package of measures announced by Chancellor Rishi Sunak in March – it’s been covering 80% of the wages of furloughed employees up to £2,500 a month. Combined with a similar scheme for the self-employed, the UK government has effectively been paying the wages of some 10.7m people at a cost of £22bn.

Why? Well measures like these have been put in place to limit the damage to the UK economy. This helps businesses reduce their costs in order to stay afloat while aiming to avoid steep rises in unemployment. Once lockdowns are eased across the country and things look a bit more normal, these jobs can hopefully be resumed.

How quickly could we see the economy rebound?

Any easing of lockdown measures are being balanced with wanting to avoid a second wave of infections and possibly another lockdown.

We could see a W shaped recovery if the re-opening of businesses and the gradual return to normality increases infection rates again and causes a second lockdown. This could then cause a second sharp drop in economic activity before a delayed recovery to complete the W shape.

We could also see a W shaped recovery if we see the sharp declines in activity levels we’ve seen so far this year reverse, and there’s an uplift in the economy as businesses reopen. But shoppers are likely to still be wary of infection while there’s no vaccine and could be cautious of spending like they normally would because of the recent uncertainty. This risks the economy dipping for a second time before starting a more sustainable recovery over the longer term.

Of course we all hope that the transmission rate falls from here and we can continue easing lockdown measures on the road back to normality. We think this type of scenario increases the chances of a U or even a V shaped recovery in economic activity. But the confidence and willingness of consumers to spend is key to the economy. Household spending (the amount spent by individuals on consuming goods and services) makes up for 63% of the economy’s GDP and this will be very important in supporting any meaningful recovery.

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