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We collectively owe £2.06tn

  • Monday, November 2, 2020

Rishi Sunak, Chancellor of the ExchequerThe coinciding of the end of the furlough scheme and further regional lockdowns has brought about an alarming increase in permanent job losses that now go beyond the hospitality and service sector. In the summer, the hopes were that the impact of Covid would be relatively short lived but a harsh reality is now setting in, that this virus is with us for far longer and will scare the economy more than hoped. Despite these fears’, consumer spending has held up and bankruptcies whilst rising are lower than expected.

The UK Job Retention Scheme due to end in October but now extended to the end of December, has run for six months costing the country £41bn. With 9.6 million people furloughed at any one point since March, the scheme did the vital job of staving off a huge rise in unemployment. The scheme is being succeeded by the Job Support Scheme which after the recent improvements in government generosity looks more like the original furlough scheme.

On top of the furlough scheme supporting 9.6 million employees, the Self-Employed Income Support Scheme received 2.7million claims for the first tranche and another 2.3 million under the second tranche, amounting to payments of £13.7bn.

The success of the programmes can only be judged when the support ends. At the end of October 66% of people that were on the furlough scheme had returned to work, but 2 million people are still on the furlough scheme and therefore at risk when the scheme ends. The position of the self-employed is more difficult to measure.

The UK job market recovery is not being helped by further lockdowns and deserted high streets. According to the Centre for Cities, vacancy levels have failed to return to pre-pandemic levels in all 63 towns and cities analysed. Aberdeen and Edinburgh recorded the steepest fall in job offerings with a drop of 75% and 57% respectively. Overall, the UK is down 46%. Sectors suffering the greatest declines were retail and leisure. People working from home has also not helped the retail or catering sectors.

With job vacancies running at such low levels this is not helping the 1.5 million people currently out of work as well as the additional 2 million still on furlough who may join them. The UK unemployment rate was 4.5% at the end of Q3 but the Bank of England monetary policy committee have warned this could rise to over 7.5%.

The Tier 3 regional restrictions and ‘Tier 4’ fire breaking lockdown in Wales and Northern Ireland and now the new national lockdown in England are putting massive pressure on families, employers, the self-employed and on the public finances.

With a W shapes recovery now looking more likely the greater the expectations placed upon Chancellor Rishi Sunak to continue with the furloughing scheme meaning even more spending on business and employment support measures.

The Office of Budget Responsibility estimates that the full cost of the furlough scheme will hit £54bn and the self-employed income support scheme hit £13.7bn. The OBR have projected that for the full 2020/21 financial year, borrowing will hit £370bn. This is also forecasted by Capital Economics who expect the UK deficit to come close to £400bn by the end of the financial year in April.

The UK national debt has now gone over £2tn and sits at 103% of our GDP. This is up from 80% of GDP twelve months ago and 35% of GDP in 2008. Between April and September, the government spent £248bn more than was raised in taxes.

The governments gilt issuance is being supported by the Bank of England using freshly printed money. Prior to Covid, the UK QE programme as a result of the 2008 financial crisis was standing at £425bn, it now stands at £725bn. The government even at interest rates of 0.1% is still spending £40bn every year on debt servicing costs. We spend the same money on our defence budget each year. Despite public debt reaching new hights not seen since the end of World War Two, economists are urging Rishi Sunak to keep spending to aid the recovery as governments can borrow money cheaply.

With a national debt at the size of the annual economy, we collectively owe £2.06tn, which under any normal circumstances, a loan to GDP level of this size would put off lenders but currently the UK government can issue 10-year gilts at 0.22 % interest rate and the Bank of England will buy them. This is one of the defining benefits of owning your currency. With inflation at 0.5% in September the cost of borrowing is less than the rate of price inflation.

The IMF has just updated its forecast for the UK and downgraded its most recent projections for GDP growth this year. The IMF expect the UK to shrink by -10.4% this year down from -9.8% they forecasted in early October. This downgrade is as a result of second wave lockdowns and growing unemployment.

The Managing Director of the IMF Ms Kristalina Georgieva praised the UK’s furlough scheme and suggested ‘that additional fiscal stimulus focused on public investment and improving the safety net’ was a good thing in order to ‘build forward’. Ms Georgieva suggested that ‘the BoE should ramp up QE and that only when the economy was recovering strongly should the government think about spending cuts or tax rises’ The IMF does not expect a dramatic drop in UK economic activity as business has learned to operate with restrictions and because of the enormous spending by the UK government.

Without doubt a concern is the long-term impact upon the country’s businesses and tax payers long after Covid becomes another flu we have to fight off every winter. The outcome will be very low interest rates for a long time, the encouragement of inflation in the economy and a tax bill lasting three generations.

The UK equity markets have not had a good year. The FTSE 100 has been lagging other leading stock markets due to a combination of the composition of the index as it holds overweight’s in energy and banks, the lack of international appetite to invest into UK companies with Brexit unresolved as well as a poor Covid response. As an example of relative strength of recovery during this crisis, the sectors that have recovered quickest have been technology, on-line retailing and home improvements. These sectors make up 40% of the US S&P 500 but only 8% of the FTSE 100.
On top of these issues the FTSE 100 is the main global index for attractive dividends. This year has seen dividends slashed or suspended to allow companies to contend with the impact of coronavirus and lockdowns. Q3 dividend pay-outs from UK listed companies was down 50% on Q3 2019. This is an improvement over Q2 when they were down 57%.

Dividend recovery is starting with corporations planning to restore dividends in Q1 2021 but analysts are expecting dividend payment to still be down on 2019 by around 10%. Much will rely on the banking sector as it supplies 20% of all FTSE 100 dividends. The recovery of dividends for the mining and oil companies will be determined by the improvements in commodity and energy prices. The pace of dividend recovery is therefore not likely to be swift. For these reasons the UK stock market is trading at its largest discount for 40 years.
Despite the arguments in favour of UK investing such as value of stock, recovering dividends, a post Brexit bounce in confidence and pent up activity, we still think that the composition of the FTSE 100 will mean sluggish performance for some time.


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Chris Davies

Chris Davies

Chartered Financial Adviser

Chris is a Chartered Independent Financial Adviser and leads the investment team.