Could the UK avoid recession this year?

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Could the UK avoid recession this year?

In May four guests had been summoned by the prime minister to debate the merits of various economic stimulus packages, and the impact such measures may have on inflation.

The four were Gerard Lyons, chief economic strategist at Netwealth; Lord Mervyn King, former Bank of England governor; Rupert Harrison, former adviser to George Osborne and chief strategist for multi-asset at BlackRock; and Minouche Shafik, director at the London School of Economics. 

The debate that had been raging in the corridors of power for months was between those who advocated a stimulus to aide economic growth and drag the economy out of stagflation, and those who believe inflation to be the bigger threat, a threat made worse by any increase in government spending. 

The deterioration in people’s view of their own finances over the next 12 months is worrying.Gerard Lyons, Netwealth

What emerged was a stimulus package, which included the much discussed windfall tax on energy company profits. The government claim the package to be worth around £15bn, and would aide the fight against the cost of living crisis. 

But will it be enough to stave of the recession the BoE expects in the UK later this year?

The parlous state of the economy is exemplified by the fact GDP contracted in March. 

Not all of the recommendations of the four economists mentioned above were the same, and not all were taken up by the chancellor.  

Sunak’s surprise 

Lyons says the £15bn package will not be enough as he feels more action is needed now as interest rates are being raised too late and demand in the economy is falling. 

He says the windfall tax on energy companies was an error, and says a recession is “likely” this year. 

Lyons adds: “There is a current debate as to how to describe this, as economic forecasts tend not to suggest there will be two successive quarters of negative growth – the technical definition of recession – nor that the UK’s annual rate of growth will dip below zero.

"However, in our view, two negative quarters of economic growth looks inevitable and a deeper downturn is possible. The GFK measure of consumer confidence has fallen to minus 38. It was only once weaker at minus 39 during the financial crisis. A year ago it was minus 15.

"The deterioration in people’s view of their own finances over the next 12 months is worrying, from a net positive balance of 10 a year ago to a net negative 26 now.”

By contrast, Rupert Thompson, investment strategist at Kingswood, says the stimulus equates to around 0.6 per cent of GDP, and says that may be enough to stave off the recession the BoE expects to happen this year, as any forecasts for negative economic growth were for a relatively minor decline this year. 

Savings glut 

Lyons' data points around the levels of consumer confidence are particularly salient in light of the savings glut that may exist in the UK and global economy. 

One of the legacies of the pandemic has been that, as we enter a period of economic turbulence, household balance sheets are in much better shape than is typically the case as recession nears.

Recessions often happen after a period of what Alan Greenspan, a former Federal Reserve chairman, calls “irrational exuberance”, where consumers and stock market investors take on new debt or reduce their savings rate beyond normal levels as they feel extremely confident about the economic outlook.

If a recession then occurs, many consumers and investors find themselves indebted just at the time when banks are less keen to extend credit, and when their employment or income prospects are diminished. 

Hanging onto this cash seems increasingly unlikely for many, with the cost of everything rising.Myron Jobson, Interactive Investor

This means that even as economies emerge from the recession and the prospects of the consumer and businesses improve, economic growth may be held back by the need to repay debts, and for banks to repair their balance sheets. 

This may be said to hinder the pace of the economic recovery, as much of the extra wealth is not spent now.

What makes the present economic situation different is the recession that resulted from the pandemic was caused not by a dissipation of savings but an excess of savings, as lockdowns meant people could not spend. 

Data from The Office for National Statistics estimates that household savings rose by 12 per cent during the pandemic.  

Research from Investec Bank calculates the average UK household had excess savings of around £4,000 coming out of the pandemic. 

Myron Jobson, senior personal finance analyst at Interactive Investor, says: “The assorted Covid lockdowns and social restrictions forced us into frugality, with household savings as a proportion of household resources hitting a record high at the height of the pandemic disruption. However, this doesn’t tell the full story.

"The ONS says consumers saving up in anticipation of a change in income or wealth and for a rainy day have also contributed to the revival of the nation’s savings culture. However, both these motives don’t appear particularly strong, accounting for 0.5 and 1.5 percentage points respectively towards the increase in the savings ratio in Q2 2020, compared to Q4 2019.

"In comparison, forced savings – those resulting from lockdown restrictions – were responsible for a whopping 11 percentage point increase. It is clear that the pandemic resulted in a seismic shift in savings behaviour.

>The GFK measure of consumer confidence has fallen to minus 38. It was only once weaker at minus 39 during the financial crisis.---Gerard Lyons, Netwealth

"The escalating cost of living crisis means that those who were fortunate enough to become accidental savers won’t be able to spend their bumper savings how they would have envisaged once Covid restrictions were lifted. Hanging onto this cash seems increasingly unlikely for many, with the cost of everything rising.”

A narrative that emerged as global economies exited the pandemic was that we could be in store for a 'roaring 20s' economy, with all the extra savings spent quickly in a way that would ensure rapid growth. This was part of the argument made by some, including James Klempster, deputy head of multi-asset at Liontrust, for rotating to value stocks in 2021. 

The mood music in the economy has changed sharply since the start of this year, with the economy actually contracting in March as the impact of much higher inflation takes hold.

Such is the present level of uncertainty in the economy that the BoE are forecasting a recession in the final quarter of this year as a result of numerous factors, including the war in Ukraine, the continuing Covid measures in China and Brexit, all pushing inflation upwards and spending downwards. 

So what of the savings glut? 

Laith Khalaf, financial analyst at AJ Bell, says the savings glut is the equivalent of “consumers having been restrained by law and are now being gradually let off the leash”.

The latest data from Barclaycard indicates that consumer spending rose by 9.3 per cent in May. 

Julian Jessop, economics fellow at the IEA, says that while the headline number looks very impressive, and implies the consumer is in rude health, that 9 per cent increase is in cash terms, and with inflation in the UK also at 9 per cent, that implies consumers are merely keeping up with their previous spending habits, rather than spending more. 

In this way, the savings glut may not help enough households to maintain their spending sufficiently to stave off the recession expected later this year.

Silvia Dall’Angelo, senior economist at Federated Hermes, says one of the issues may be that much of the excess savings is in the hands of people who worked from home during lockdown periods, and the bulk of those are people in higher income brackets and so with less propensity to spend any excess. 

In that scenario, the excess savings do not replace the aggregate demand lost as a consequence of the higher inflation, and demand in the economy overall is reduced. 

If the excess savings do not translate into an increase in spending at least matching the rate of inflation, whether there is a recession or not, it would have an extremely negative impact on the retail sector and other parts of the economy.