The British financial sector and economy are showing signs of entering a new phase in the business cycle. We have consistently made the case that V stood for vaccine and not the shape of the recovery. Thanks to the life sciences community and National Institutes of Health, there is now a vaccine, and we can focus on economic recovery and expansion in the U.K. economy.
The RSM U.K. Financial Conditions Index, at one standard deviation above neutral, implies that conditions are ripe to support a robust reopening of the British economy.
Pandemic and coronavirus curves
Yet nothing about this pandemic has gone in a straight line, and the last half of May is a good example. Newly reported cases of COVID-19 are rising again in the U.K., from fewer than 2,000 per day at the start of May to 3,600 in the first days of June. This comes at a time when second doses of the vaccines are being applied and deaths have retreated to fewer than seven per day.
The RSM U.K. Financial Conditions Index shows that the appetite to take risk is supporting economic growth and recovery.
When measured by preventing deaths, the U.K’s policy of distributing a first dose as widely as possible before shifting focus to the second dose is an apparent success. In effect, the world’s population is undergoing a clinical test, and it will be interesting to see which of the vaccination programs will be the model for pandemics to come.
According to the BBC, the range of first-dose vaccinations for those 18 and older runs from 71% of Northern Ireland’s adult population to 84% in Wales. Roughly 45% of the U.K.’s adult population has received a second dose.
U.K. financial conditions
The benefits to the economy and financial sector are becoming evident in the latest RSM U.K. Financial Conditions Index, a composite indicator of the risk and perceptions of economic growth priced into several financial assets.
The index remains almost one standard deviation above neutral financial conditions, indicating that the appetite to take risk is supporting economic growth and recovery. The core conclusion is that the economy is ready to emerge from its more than year-long hibernation.
And with the focus having shifted to vaccinating those under 50, the preconditions are in place for what we expect to be a robust three-year period of economic recovery and expansion.
The path is clear for the U.K. economy to begin accelerating into recovery this year and expansion next year. Bolstered by household spending and monetary and fiscal accommodation, the economy will grow faster than 6% this year with the potential for higher growth next year.
Prelude to a robust expansion
The monetary and fiscal authorities have completed the groundwork for that recovery. Because economic policy efforts (and adverse shocks like the pandemic) are transmitted to the economy through the financial markets, there has been a worldwide effort to maintain liquidity necessary for commercial transactions and to reduce risk.
The monetary and fiscal authorities have completed the groundwork for a recovery.
Domestic financial conditions as measured by the index turned positive in February after a year of increased risk priced into the asset markets. The index has settled into a narrow range of roughly one standard deviation above neutral for the past 14 weeks, with recent downward pressure coming from an aberrant equity market valuation last year.
These conditions point to a climate of improved risk appetite among investors and confidence in the normalization of social and economic interaction.
As with the recent increase in infections, we cannot expect this to happen overnight. The Bank of England reported that consumers continued to pay down their credit card debt in April, which suggests further rebalancing of household finances, but with the potential for greater spending in the months ahead. The central bank also reported a 25% increase in lending to small and medium-sized enterprises, which is a sign of revitalization.
The same cannot be said for large nonfinancial businesses, which made significant net repayments of their loans in April and whose investment is essential for sustained economic growth.
Still, the potential for growth is there. We expect the public to gain confidence in the vaccine and in its safety at work and on the High Street. And we anticipate that financial conditions will remain conducive for a reflation of the U.K. economy.
Economic progress report
Signs of economic progress are popping up. The U.K. manufacturing production index grew for the first time in 24 months. That was confirmed by the production component of the U.K. monthly gross domestic product index, which grew in March for the first time since the unofficial start of the global manufacturing recession in September 2018.
The service sector still lags the recovery in the production sector, though it managed yearly growth of 0.7% in March.
There are clearly both base-period effects and spillover effects from the United States – where industrial production turned positive in March and grew by 16.5% in April — and in Canada, where the all-industries real GDP had annual growth of 6.6% in March.
As expected, and because of the lingering effects of the pandemic, the service sector still lags the recovery in the production sector. Nevertheless, the service sector managed yearly growth of 0.7% in March after 12 consecutive months of decline. We expect that to continue as vaccinations foster consumer confidence in a safe environment.
Despite the gains in both the production and service sectors, this is only one month after a most difficult year. We expect the Bank of England to maintain its policy of accommodation for the rest of the year and until normalcy is assured.
But the positive signs are there. Firm managers, investors and policymakers should anticipate a quicker recovery than previous recessions and an explosion of household spending later this year.
For more information on how the coronavirus pandemic is affecting midsize businesses, please visit the RSM Coronavirus Resource Center.
