Our proprietary index implies that financial conditions are ripe for a robust recovery of the British economy.
Bond market spilloverBecause of the financial markets’ global nature, it’s hard to discern the difference in individual bond market reactions to the major economic and financial events of the past decades. Long-term interest rates in the U.K. and the United States have been in secular decline in response to slowing growth among the developed economies, with Brexit turmoil having a more intense impact on gilt yields than on U.S. Treasury bonds. So it should be of little surprise that bond yields in the U.K. and the United States have declined in recent weeks despite prospects for improved growth. The yield on 10-year gilts flirted with yields below 0.5% on three consecutive days in the first week of August, keeping in step with the pattern of U.S. Treasury bonds that had similar dips below 1.15%. There are several likely reasons for this downturn in yields. These include the increased demand for bonds—because of the near-zero return on short-term securities—butting up against a diminished supply of bonds because of central bank asset purchases. And if the local economies were to continue to open up and tax revenues increase, that could lower the need for bond issuance. But unless this turns out to be a short-term technical correction, there is the likelihood that the bond market is reconsidering the ability of economies to quickly snap back to normal.
The health crisisThe world remains in the midst of a health crisis, and total global economic activity will not return to pre-pandemic levels until vaccines have had broad distribution. Although the COVID-19 vaccination program in the U.K. appears to have blunted the rise of the delta variant, a substantial segment of the U.S. population (and now the French) remains unvaccinated. Newly reported cases of COVID-19 infections in the U.K. have dropped from 47,000 per day six weeks ago to about 26,000 per day, according to data compiled by Worldometers. That the virus is reportedly affecting unvaccinated younger people lends hope that this fourth wave will not be as deadly as earlier spikes. Nevertheless, 26,000 new infections each day is not a small number.
Long-term economic scarringAfter five quarters of decline, the consensus among economists polled by Bloomberg is for the U.K. economy to finish the year with substantial growth in the third and fourth quarters, then grow by more than 5% next year before settling back down to earth with 2% growth in 2023.
The Bank of England revised down its estimate of long-term economic scarring from 1.25% to 1%.