Despite the dark winter caused by the global pandemic, financial conditions in England have moved in a constructive direction that can support a near-term economic recovery and expansion in 2022.
Volatility is subsiding, and performance among the markets suggests a platform for growth into next year.
Volatility in the U.K. financial markets is subsiding, and performance among the markets appears to suggest a platform upon which the economy can begin the long road to recovery.
While the coronavirus was peaking in early January, the RSM UK Financial Conditions Index began its approach to neutral levels, indicating a move toward normal degrees of risk and performance among the currency, equity and fixed-income markets.
Because economic growth depends on stability in the financial markets — particularly in the fixed-income market — we consider the return to normality as a first and important step.
Notably, the bond market is showing glimpses of optimism in the economy. The yield on 10-year gilts increased by 20 basis points in January, steepening the yield curve a bit, while corporate yield spreads continue to price in less risk.
Though the pound and FTSE 100 continue to underperform past performance, we assign less responsibility for the growth of the economy to these markets than we do to the bond market.
And while we can attribute the pound’s recent malaise to the threat of negative interest rates, both the currency and equity markets are nevertheless improving from low levels of performance after years of Brexit and political turmoil.
There is one other potential sign of increased economic activity that comes with a caveat. The price of oil (which we do not include in our index) has been increasing, which given the shrinking reliance on fossil fuels might be a sign of increased global economic activity.
Along with the increase in oil prices, there has been an uptick in U.K. consumer prices that could be a function of OPEC manipulation, but also perhaps an increase in U.K. consumer and manufacturing demand.
As to repairing the damage from the pandemic, Britain has the highest rate of deaths per population among developed economies. New cases of coronavirus infections are being reported at a rate of more than 22,000 per day, which is substantially less than the nearly 60,000 earlier in January, but still high.
The vaccine cannot come soon enough, both in terms of human misery and the economic fallout. As we found after the last existential shock to the economy – the 2008 financial crisis – the longer and deeper the downturn, the greater the likelihood of long-term detrimental effects on the labour force, reduced and delayed investment, and diminished potential economic growth.
We expect the Bank of England to retain its defensive posture and to continue its role as the facilitator of emergency fiscal policy. The central bank’s mission will be to fund government spending to keep cash in the hands of consumers and avert a depression. That mission will then be to keep long-term interest rates low in order to finance the cost of pandemic-incurred debt over time.
We expect the Bank of England to maintain its policy rate of 0.1% and a robust pace of asset purchases throughout the year.
It is up to the political authority to extinguish the pandemic, re-establish a fully employed and productive labour force, and maintain expectations for economic growth.
For more information on how the coronavirus pandemic is affecting midsize businesses, please visit the RSM Coronavirus Resource Center.
