Financial markets continue to signal little to no unease over the spread of the delta variant in the latest manifestation of the global pandemic as the United Kingdom moves toward a wider reopening on July 19. Despite the public health risks around the variant, financial conditions imply rising risk appetite and are supportive of growth as the economy enters the third quarter of 2021.
Our RSM UK Financial Conditions Index, which is a composite indicator of the risk and perceptions of economic growth being priced into several financial assets, has finally breached 1.0 standard deviation above normal levels of risk. After years of increased risk and austerity, this a milestone in recent U.K. financial history.
In the United Kingdom, vaccinations continue and deaths attributed to COVID-19 are becoming rare. Still, roughly 14,700 new cases are reported per day, with the delta variant comprising 99% of all genetically sequenced cases, according to reports. That the virus is predominantly affecting unvaccinated younger people—for whom the vaccines are now available—lends hope that this fourth wave will be truncated and not as deadly as earlier episodes of the pandemic.
Volatility in the currency and equity markets is down, and money market and corporate bond spreads are below pre-Brexit, non-crisis levels. Damped volatility underscores the calm across financial markets and a potent framework under which domestic firms should feel comfortable engaging in prodigious capital investments after years of weakness that were one of the hallmarks of the Brexit-era British economy.
The last time the financial markets were so at ease was July 2014. The United Kingdom had weathered the European debt crisis, David Cameron was four years into being prime minister, and the U.K. was two years from deciding to leave a barrier-free Europe, its largest trading partner.
It was downhill from there, with political upheaval adding to increasing uncertainty over the economy as Brexit became less distant. With more and more risk being priced into financial assets, investment suffered, flattening out after the referendum and then sliding during the U.S. trade war and plummeting during the pandemic.
But the monetary authorities responded quickly. Financial conditions are now so accommodative that the path is clear for the U.K. economy to begin accelerating into recovery this year and into expansion next year. Bolstered by household spending and monetary and fiscal accommodation, we anticipate the economy will grow by more than 6% this year, with the potential for higher growth in the following year should the pandemic end as fast as it started and business investment follows suit.
A recent analysis from the Bank of England backs up that optimism. The recent paper found that household finances were in better shape before the pandemic than prior to the global financial crisis. Furthermore, the bank’s analysis finds little evidence that household debt amplified the pandemic-induced recession. While there is certainly distress for some households, the authors suggest that “the particular nature of the crisis and the unprecedented policy interventions—such as income support and payment deferrals” have supported household finances.
Another survey from the bank found that although business investment declined by 25% during 2020-21, financial officers plan to increase investment now that uncertainty over Brexit and the health crisis has receded. Furthermore, a set of corporate tax changes have created an incentive for businesses to invest.
The survey’s conclusion is broadly consistent with analysis by the Office for Budget Responsibility, which estimates that business investment would increase by up to 10% during 2022-23.
Both papers add caveats to their analyses, however. Household spending will depend on the evolution of the pandemic and subsequent government responses to further outbreaks, while the timing and depth of business investment will depend on variation among business responses to the budget actions and to future increases in corporate tax rates.
