While the medical and life sciences communities were doing the remarkable work of developing three effective coronavirus vaccines over the past year, global monetary and fiscal authorities have been laying the groundwork for an economic recovery.
With the introduction of the latest U.K. budget, we anticipate that financial conditions are conducive to a reflation of the U.K. economy and growth rates at or above 4% this year with risk of a quick pace of growth.
The RSM UK Financial Conditions Index turned positive in the first week of February, and it has remained there ever since — an encouraging sign. At 0.38 standard deviations above normal conditions, the index is an indication of accelerating growth in the coming quarters.
Financial markets reacted positively to the introduction of the most recent budget proposal by Chancellor of the Exchequer Rishi Sunak that included an extension through June of the government’s plan to pay 80% of wages to workers affected by the government shutdown. This will prevent a notable increase in unemployment.
Overall government debt will increase to 97% of gross domestic product by 2024-25. More important, 600,000 people who previously were not qualified to receive the aid, including those who became self-employed after the 2019-20 tax year, are now eligible.
The RSM index turned positive in the first week of February, and it has remained there ever since — an encouraging sign.
This increased aid will cost close to £9 billion. In our estimation, this will prevent some long-term economic scarring in the labor market and is well worth the cost. While the introduction of a green infrastructure and eight U.K. freeports, where normal tax and customs rules do not apply, will add to revenue coffers, it will not be sufficient to offset spending elsewhere.
On the tax front, the U.K. business tax holiday will remain in effect until June and keep the value-added tax rate reduced through Sept. 30. But the U.K. will increase the corporate tax rate to 25% in 2023. The increase in taxes is expected to bring in an additional £45.4 billion between 2023 and 2026.
The growth outlook was revised down to 4% for this year and is expected to arrive at 7.3% next year, with the U.K. economy returning to its pre-pandemic levels by the middle of next year. All of this points to Bank of England monetary policy remaining at near zero and in an accommodative stance for the foreseeable future.
The index
The RSM UK Financial Conditions Index is a composite indicator of the risk and perceptions of economic growth being priced into several financial assets. That it has moved above zero should be a sign that the worst of the economic damage has passed. But more important, positive financial conditions reflect a recognition of the unbelievable work done by the scientists and health-care providers.
As with other developed economies, the U.K. equity market is pushing toward reversing last year’s crash and the bond market is showing increased expectations of recovery and growth. The yield on 10-year gilts continues to inch higher in relation to money-market rates anchored near the zero lower bound. Corporate yield spreads continue to indicate diminished risk of corporate default.
Still, we should take a step back. Though a steepening yield curve suggests an economy that can support higher inflation and higher long-term yields, we are talking about 10-year yields that have yet to crack 1%.
And the monetary authorities are unlikely to ease their downward pressure on the long end of the yield curve until the economy has moved past all the Brexit disruptions to commerce and the pandemic’s effect on ordinary life and consumer spending.
In addition, spending plans in the budget report reinforce the need for the Bank of England to keep a lid on long-term interest rates. There are unavoidable pandemic expenses ahead of us, as well as a need for direct aid for displaced workers and investment in the advanced industries that will allow the economy to compete in the global supply chain.
For more information on how the coronavirus pandemic is affecting midsize businesses, please visit the RSM Coronavirus Resource Center.
