Press release

9 Apr 2020 London, GB

GDP contraction of 0.1% in February shows a subdued UK economy before coronavirus started to impact, says EY ITEM Club

The UK economy’s performance in February now seems from a different era but GDP contraction of 0.1% month-on-month after growth of just 0.1% in January means that it had a lacklustre start to 2020 even before coronavirus began to really impact.

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  • The UK economy’s performance in February now seems from a different era but GDP contraction of 0.1% month-on-month after growth of just 0.1% in January means that it had a lacklustre start to 2020 even before coronavirus began to really impact. Indeed, GDP was only up 0.1% in the three months to February compared to the three months to November.
  • GDP fell 0.1% month-on-month in February as construction output contracted 1.7% month-on-month and services output was only flat. Manufacturing output rose 0.5% although industrial production was only up 0.1% overall. Even allowing for some hit to construction activity (and retail sales) from the very wet weather, this was a lacklustre performance.
  • The hope had been that improved business and consumer confidence resulting from reduced uncertainties after December’s election – reinforced by the UK leaving the EU with a deal on 31 January – would fuel a clear pick-up in economic activity early on in 2020. However, while confidence did pick up, this failed to translate into significantly improved economic activity.
  • The economy obviously took a very substantial hit in March as the coronavirus outbreak increasingly impacted, with mounting restrictions on people’s movements and business activity, culminating in the lockdown on 23 March. EY ITEM Club suspects the UK economy saw a substantial contraction in March (possibly up to 5%), resulting in GDP contraction of around 1.3% in the first quarter.
  • EY ITEM Club is forecasting GDP contraction of around 13% quarter-on-quarter in the second quarter – with consumer spending likely falling around 14% in the face of markedly higher unemployment, reduced incomes, lower consumer confidence and caution over making discretionary purchases, as well as the closure of non-essential retailers, pubs, restaurants, cinemas, gyms, clubs and other consumer services. Business investment is also expected to fall sharply in the second quarter.
  • EY ITEM Club has downgraded its UK GDP forecast for 2020 to show contraction of 6.8%. On the assumption that coronavirus peaks in the second quarter and that the Government starts to relax restrictions late on in the quarter (and more so in the third quarter), we expect the economy to start recovering in the third quarter. The substantial fiscal and monetary stimulus that has been enacted should provide serious support to activity once the coronavirus impact starts to wane, while consumer purchasing power should benefit from very low inflation. However, the upside for consumer spending is likely to be limited by higher unemployment.
  • We expect the UK economy to grow 4.5% in 2021 as it continues to recover from the substantial but short-term impact to activity from coronavirus in the first half of 2020. However, the economy is not expected to return to its size of the fourth quarter of 2019 until the first quarter of 2023. The forecast assumes that the UK and EU will avoid a “no deal” outcome at the end of 2020 when the Brexit transition arrangement is due to end.
  • A downside risk to the outlook is if coronavirus affects the economy longer than expected.

Howard Archer, chief economic advisor to the EY ITEM Club, comments:

Disappointing news on the UK economy as GDP dipped 0.1% month-on-month in February and was up just 0.3% year-on-year. This followed GDP growth of 0.1% month-on-month in January (revised up from flat).

GDP fell 0.1% month-on-month in February as construction output contracted 1.7% month-on-month and services output was only flat. Manufacturing output rose 0.5% although industrial production was only up 0.1% overall. Even allowing for some hit to construction activity (and retail sales) from the very wet weather, this was a lacklustre performance.

Consequently, GDP was up just 0.1% in the three months to February compared to the three months to November, with only the services sector (0.2%) seeing growth. There was three-month/three-month contraction in industrial production (0.6%) and construction (0.2%).

The hope had been that improved business and consumer confidence resulting from reduced uncertainties after December’s election – reinforced by the UK leaving the EU with a deal on 31 January – would fuel a clear pick-up in economic activity early on in 2020. However, while confidence did pick up markedly, this failed to translate into significantly improved economic activity.

UK economic impact in March from coronavirus

The UK economy took a substantial hit in March as the coronavirus outbreak increasingly impacted, with mounting restrictions on people’s movements and business activity, culminating in the lockdown on 23 March. We suspect the economy could have contracted by up to 5% in March, resulting in GDP contraction of around 1.3% in the first quarter.

There is little hard data out so far to gauge just how much the economy was affected in March. Survey evidence from the purchasing managers points to a very sharp fall off in activity, although it needs to be kept in mind that the purchasing managers’ surveys can tend to overstate developments at times of changing economic, political and other developments. Specifically, the composite output index for manufacturing and services plunged to 36.0 in March; this was the lowest level in the survey’s 22-year history. The previous low was 38.1 in November 2008. March’s reading was down from 53.0 in March and 53.3 in January (which had been the highest level since September 2016). Furthermore, March’s drop of 17.0 points was by far the largest single monthly decline on record.

A third survey from the purchasing managers relating to the construction sector showed a sharp fall back in activity in March as many sites were closed. Indeed, the construction PMI fell to 39.3 in March (from a 16-month high of 52.6 in February) taking it to the lowest level since April 2009.

On the consumer front, GfK reported that consumer confidence saw a substantial deterioration over the second half of March. Specifically, the index slumped by 25 points to -34 from -9 with a deterioration in consumers’ expectations for the economy and for their personal finances. This took consumer confidence down to the lowest level since February 2009. There was an astonishing 50 points drop in the index relating to the major purchase index. Meanwhile, new car sales fell 44.4% y/y in the key month of March (due to the number plate change) with private sales declining 40.4% y/y and fleet sales down 47.4% y/y. This was the weakest March performance for new car sales since bi-annual number plates were introduced in 1999.

Outlook

We have reduced our UK GDP forecast for 2020 to show contraction of 6.8%. This is expected to be followed by growth of 4.5% in 2021.

We expect the economy to contract around 13% quarter-on-quarter in the second quarter after an estimated decline of 1.3% in the first quarter. Consumer spending is expected to fall around 14% in the face of higher unemployment, reduced incomes, lower consumer confidence and caution over making discretionary purchases as well as the closure of non-essential retailers, pubs, restaurants, cinemas, gyms, clubs and other consumer services. Business investment is also expected to fall in the second quarter.

While there is no denying that there are substantial downside risks, we believe the economy can start to recover in the third quarter and then see decent activity late on in 2020 and during 2021. This is on the assumption that coronavirus peaks during Q2 2020 and the Government starts to relax some of the restrictions on people’s movements and on business activity late on in the quarter and further loosens them during Q3. However, the Government warned at the end of March that normal life in the UK may not return for up to six months.

The substantial fiscal and monetary stimulus that has been enacted should provide serious support to activity once the coronavirus impact starts to wane, while consumer purchasing power should benefit from very low inflation. There should also be a fair degree of pent-up demand following the decline in consumer spending in Q2 2012 due to the lockdown. We assume that the Government’s measures aimed at supporting businesses and saving jobs will have a significant positive impact. This is crucial to limiting the potential longer-term damage to the economy and enabling decent recovery to get underway in the latter months of 2020. Nevertheless, unemployment is expected to have risen significantly and this will have some limiting impact on the recovery. Global economic activity should also be stronger later on in 2020 and during 2021 as other economies recover from the coronavirus. Consequently, we believe the UK economy could grow by 4.5% in 2021 after the expected contraction of 6.8% in 2020.

Potential downside risks to the outlook include coronavirus affects the economy longer than expected, or companies going under and jobs lost, which may hold back the subsequent recovery.