Covid-19 will bring "deep short recession"

The EY ITEM Club Spring Forecast 2020 has significantly downgraded its near-term outlook for the UK economy, with predictions of a deep, short recession this year due to the impact of COVID 19. UK GDP is now expected to contract by 6.8% in 2020, before returning to positive growth of 4.5% in 2021.

The forecast is based on the assumption that some lockdown restrictions will start to be eased in May, with even more in June. EY ITEM Club says that the substantial fiscal and monetary stimulus that has been enacted by the Treasury and the Bank of England should provide serious support to activity once the Coronavirus impact starts to wane but, even with these measures, the UK economy is not expected to return to its Q4 2019 size until 2023.

Howard Archer, chief economic advisor to the EY ITEM Club, says: “The UK economy is clearly in for a very difficult year with GDP expected to contract around 13% quarter-on-quarter in Q2. To put this into perspective, the largest quarter on quarter contraction suffered during the 2008/9 financial crisis was 2.1% in Q4 2008. Our report assumes that the Government’s measures aimed at supporting businesses and saving jobs will have a significant positive impact, which is absolutely crucial to limiting the potential longer-term damage to the economy.”

The EY ITEM Club forecasts that consumer spending will contract by around 14% in Q2 compared to the previous three months, and by 7.5% over 2020 as a whole, before rebounding to growth of 4.9% in 2021. The report says that there should be a fair degree of pent-up demand following a collapse in consumer spending in Q2 this year due to the lockdown.

Consumer Price Inflation (CPI) is expected to fall as low as 0.5% over the summer and to start edging up in the latter months of 2020, before then heading towards 2% in 2021. Low inflation for much of the year should support consumer spending. However, the report warns that the UK labour market is unlikely to recover all the job losses suffered in 2020 and that will also have some limiting impact on consumer spending.

Indeed, the report predicts that the unemployment rate could rise as high as 6.8% in Q3 2020, up from 4.0% in the three months to February. Combined with significantly lower levels of consumer confidence and reduced income for many workers, the EY ITEM Club says this is likely to weigh heavily on discretionary spending.

However, global economic activity should be markedly stronger from the latter months of 2020 and during 2021 as other economies recover from the results of coronavirus, providing a further support to recovery prospects and helping UK exports.

According to the report, levels of business investment will be heavily impacted in Q2 this year and likely beyond with many companies focused on getting through the near-term crisis rather than planning for a future that they may not have – particularly as they cannot be sure of how long coronavirus will impact the economy.

According to the forecast, business investment is expected to fall 13.6% in 2020. It is expected to be up 1.2% in 2021 and 6.5% in 2022 as the economy and confidence recover. The 1.2% increase forecast in business investment in 2021 masks a significant pick up during the year.

Simon O’Neill, office managing partner for EY in the Midlands, comments: “I appreciate how difficult it is to look beyond the immediate challenges, but businesses need to prepare for a period of prolonged change. Based on the forecast for this year alone, around 44% of consumer spending – the major engine of UK growth over the last couple of decades – is at risk of either being delayed or lost completely.

“In this highly uncertain environment, businesses need to think differently about how they plan in order to test the resilience of their operations and finances against a range of plausible shocks and how they adapt to longer term changes in customer behaviour.

"The Coronavirus is likely to accelerate some of the emerging trends we’ve seen in recent years, particularly around deglobalisation, the rapid introduction of new technologies and decarbonisation. So, while the UK economic impact will hopefully be short lived, the business impact is expected to be of a longer duration.

“Whilst all sectors have been heavily impacted by COVID-19, some have felt it more keenly than others. In the Midlands, where there is a concentration of automotive and manufacturing businesses, many rely heavily on the export market for sales and import market as part of their supply chain. Many of these businesses have had to take the difficult decision to furlough staff, utilising the support available from central government. At a time where cash flow is key, it is likely to  be difficult for some even when restrictions start to ease.”

The EY ITEM Club says net trade is expected to make a marginal negative contribution of 0.1 percentage point to GDP growth in 2020, with exports of goods and services forecast to fall by 5.3% while imports decline by 4.9%. Net trade is then expected to make a larger negative contribution in 2021 as exports (up 6.3%) are forecast to be outgrown by imports (up 8.4%).

The report predicts that UK exports will be hit in 2020 by the contraction of key overseas markets for the UK, notably including the EU and the US. Furthermore, some exports could be affected by production problems in the UK if coronavirus significantly affects workforces.

EY ITEM Club warns of the significant downside risks to the forecast, notably if Coronavirus affects the economy longer than expected. This includes the possibility of a significant new Coronavirus wave returning after restrictions have been eased, or continued consumer caution, for an extended period.

EY ITEM Club says that a more fundamental downside risk is if the economy suffers severe near-term damage from companies going under and jobs lost – despite the Government’s supportive measures – and if this holds back the subsequent recovery.

Pictured: Simon O'Neill