We are not out of the woods yet.
- Friday, April 3, 2020
The coronavirus is having a severe effect on global economic activity and amidst considerable uncertainty analysts and economists are trying to gauge the impact and update forecasts. Several are suggesting that the world economy will contract this year by 3%, before rebounding by 7% in 2021. These forecasts incorporate a severe recession in the first half of the year which, even with a rebound in the second half, means 2020 is set to be the worst year for activity since the 1930s.
Although there is considerable support from central banks and governments, the dramatic downturn reflects the effect of shutting down large parts of the economy as the authorities attempt to suppress the virus.
An indication of the magnitudes can already be seen in the latest data from China, where we saw falls of 20% in retail sales and 25% in fixed capital investment during the period when much of the economy was in lockdown. Thankfully the number of new Covid-19 cases in China has levelled out, but we are at an earlier point on the curve in Europe and the US.
This results in a significant hit to activity in Q2 in the US and Europe with falls in GDP of between 10 and 20%. Such outcomes have rarely been seen in the post war economies where normal fluctuations in GDP are between 1% and 2%.
It is vital that the financial system continues to provide liquidity to firms and households so they can withstand the impact of the collapse in activity on cash flow. Otherwise a temporary hit will cause permanent damage to the supply side of the economy. If we see a widespread collapse of business there will be little left to support the recovery.
In this respect, lower interest rates are less important than measures to ensure banks have the confidence to lend rather than foreclose on borrowers, and liquidity continues in commercial paper and credit markets. The Bank of England’s actions combined with government guarantees on loans and measures to ease cash flow such as the suspension of business rates all help in the UK.
More widespread use of fiscal policy, such as the President Trump plan to give lower and middle income households US$1000 each, would also be helpful to support consumption in the face of the inevitable increase in unemployment.
It is expected that the measures taken to contain infection to be effective in the US and Europe and alongside a seasonal fall back in the virus during the northern summer, the economy should experience a strong rebound as people go back to work in the third quarter. The policy bazooka will then be fully felt as low interest rates, tax cuts and increased government spending continue.
Going into 2021 we could expect a modest tightening of monetary policy around the world as the global economy booms.
Chris DaviesChartered Financial Adviser
Chris is a Chartered Independent Financial Adviser and leads the investment team.