Press release

12 Aug 2020 London, GB

UK economy saw record contraction despite June’s marked improvement in activity – EY ITEM Club comments on GDP figures

The UK economy saw record GDP contraction of 20.4% quarter-on-quarter and 21.7% year-on-year in the second quarter of 2020

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Related topics Growth COVID-19
  • The UK economy saw record GDP contraction of 20.4% quarter-on-quarter and 21.7% year-on-year in the second quarter of 2020
  • With GDP having previously contracted 2.2% quarter-on-quarter in Q1, the UK officially moved into recession. GDP in Q2 was 22.1% below the 2019 Q4 level
  • GDP grew 8.7% month-on-month in June amid a significant easing of lockdown restrictions. This marked a second month of growth following expansion of 2.5% (revised up from 1.8%) in May. However, this was outweighed over the second quarter as a whole by GDP falling a record 20.0% (revised from 20.4%) in April
  • June’s pick-up in growth was the consequence of decent month-on-month output growth across all sectors: services (8.7%), industrial production (9.3%) with manufacturing output (11.0%), and construction (23.5%). It was notable that services output improved after very limited growth in May that held back overall growth
  • All output sectors saw quarter-on-quarter contraction over Q2: services (19.9%), industrial production (16.9%) with manufacturing output (20.2%), and construction (30.5%)
  • On the expenditure side, falls in consumer spending and business investment were particular drags on the economy. Consumer spending (down a record 23.1% quarter-on-quarter) was largely affected by the restrictions on activity, weakened consumer fundamentals and low confidence. There was also a significant drop in business investment (31.4%) as companies experienced reduced activity and cash flow concerns. Lower stocks also had a negative effect. The only positive contributions came from government investment (up 11.4% quarter-on-quarter) and net trade but only because imports (down 23.4%) fell sharply more than exports (down 11.3%)
  • While the UK recession involved a record contraction, it should at least be limited to two quarters. The economy has been growing at an increasing rate since May and it appeared to take a another step forward in July as lockdown restrictions were eased further
  • The EY ITEM Club expects GDP growth around 12% quarter-on-quarter in Q3 as the economy benefits from reduced lockdown restrictions. This assumes that there are no further widespread restrictions put in place as a consequence of renewed higher levels of coronavirus cases
  • The EY ITEM Club suspects growth is likely to slow in Q4 as unemployment rises. Recent redundancy announcements highlight the risk to the recovery from higher unemployment. The EY ITEM Club expects GDP to contract 11.5% over 2020
  • The EY ITEM Club sees GDP growth at 6.5% in 2021 as the recovery is limited by persistent consumer caution, higher unemployment and only slowly recovering business investment
  • The EY ITEM Club believes that the economy might not regain its Q4 2019 size until 2024
  • Downside risks for the forecast include a second coronavirus wave that necessitates renewed lockdowns, persistent cautious business and consumer behaviour, an even higher rise in unemployment, and a ‘no deal’ outcome at the end of the Brexit transition period on 31 December

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

“UK GDP contracted a record 20.4% quarter-on-quarter and 21.7% year-on-year in the second quarter, primarily due to the record fall in activity in April when lockdown restrictions were fully in place. With the economy earlier contracting 2.2% quarter-on-quarter in the first quarter (which, at the time, had been the equal sharpest decline since the third quarter of 1979), the economy moved into recession over the first half of the year. Indeed, GDP in the second quarter was 22.1% below the level seen in the fourth quarter of 2019.

“After April’s fall of 20.0% month-on-month, which accounts for the overall second quarter contraction, GDP grew 2.4% (revised from 1.8%) month-on-month in May when there was a modest first easing of the lockdown restrictions.

“The economy took a significant step forward in June when GDP expanded 8.7% month-on-month amid a further easing of lockdown restrictions. This included non-essential retailers being allowed to open from the middle of the month. June’s marked pick-up in growth was the consequence of decent month-on-month output growth across all sectors: services (8.7%), industrial production (9.3%) with manufacturing output (11.0%), and construction (23.5%). It was notable that services output improved after comparatively limited growth 0f 1.5% in May that held back overall growth.”

All output sectors saw contraction in first quarter

Howard Archer continues: “Despite June’s improvement, there was a substantial quarter-on-quarter contraction across all output sectors in the second quarter. Output in the dominant services sector fell a record 19.9% quarter-on-quarter following a drop of 2.3% quarter-on-quarter in the first quarter. The sharpest declines occurred in the accommodation and food services sectors, wholesale and retail trade and repair of motor vehicles, human health and social work activities, and education as they were affected by “business closures, shutdowns among clients or shrinking survey record low sales due to a slump in non-essential spending”.

“Industrial production contracted 16.9% quarter-on-quarter with manufacturing output declining 20.2% quarter-on-quarter. This followed respective drops of 1.5% quarter-on-quarter and 1.1% quarter-on-quarter in the first quarter. Manufacturing output was particularly affected by a 49.1% drop in the manufacture of transport equipment due to widespread factory shutdowns during the lockdown period.

“Construction output fell 30.5% quarter-on-quarter in the second quarter after a decline of 1.7% quarter-on-quarter in the first quarter. Private new house work fell by 51.2%.

“Many manufacturing plants (notably in the car sector) and construction sites were closed throughout April before starting to re-open from May.”

Record falls in consumer spending and business investment significantly affected economy in second quarter

Howard Archer continues: “On the expenditure side of the economy, record falls in consumer spending and business investment weighed on the second quarter figures, while there were also negative contributions from government spending and stocks. The only positive contributions came from government investment as a consequence of efforts to support the economy and net trade but only because imports fell sharply more than exports.

“Consumer spending declined 23.1% quarter-on-quarter in the second quarter and was down 25.2% year-on-year as it was affected by the restrictions on activity (particularly in April), worsening consumer fundamentals and weakened confidence. This followed a drop of 2.9% quarter-on-quarter in the first quarter. Non-essential retailers were shut from 23 March through to mid-June while some parts of the consumer services sector were effectively brought to a halt for much of the second quarter by the lockdown including the closure of theatres, cinemas, gyms, restaurants, pubs, and clubs. Meanwhile, jobs were cut and incomes affected during the quarter, despite the supportive government measures.

“Overall investment fell 25.5% quarter-on-quarter in the second quarter after a drop of 1.1% in the first quarter. Business investment fell 31.4% quarter-on-quarter in the second quarter after a drop of 0.3% quarter-on-quarter in the first quarter as companies faced reduced activity, weakened cash flows and uncertainties. There was contraction of 39.4% quarter-on-quarter in private dwellings investment in the second quarter. However, government investment rose 11.4% quarter-on-quarter.

“Government spending fell 14.0% quarter-on-quarter and 16.9% year-on-year. This followed a fall of 4.1% quarter-on-quarter in the first quarter which reflected lower spending on health and education.

“There was a negative impact from lower inventories – stocks held by UK companies fell by £2.5 billion over the second quarter. This was led by a fall in the level of stocks held within the wholesale and retail trades, though partially offset by increases in stock levels held in mining and quarrying, which increased as a result of falling oil prices.

“Net trade made a major positive contribution to second quarter GDP, but only because imports declined even faster than exports. Net trade had made a considerable negative contribution in the first quarter. Exports fell 11.3% quarter-on-quarter in the second quarter as most countries experienced contraction and global trade weakened; this followed a decline of 13.5% in the first quarter. Imports contracted 23.4% quarter-on-quarter in the second quarter, reflecting the weakness of UK domestic demand; this followed a decline of 9.4% quarter-on-quarter in the first quarter.”

Economy appeared to take significant step forward in July as restrictions eased further

Howard Archer observes: “The UK economy appears to have built on June’s improvement in July, helped by a further easing of lockdown restrictions.

“In particular, the purchasing managers released a set of improved purchasing managers' surveys for services (up to 60-month high of 56.5 from 47.1 in June), manufacturing (up to 16-month high of 53.3 from 50.1) and construction (up to 57-month high of 58.1 from 55.3).”

Outlook

Howard Archer continues: “The EY ITEM Club expects the economy to return to clear growth in the third quarter with GDP expanding at least 12% quarter-on-quarter. The economy should benefit from the reduced lockdown restrictions.

“The substantial fiscal and monetary stimulus that has been enacted should provide ongoing support to the economy. While some of the emergency fiscal measures will wind down over the coming months – such as the jobs retention scheme ending in October – the Chancellor announced further near-term stimulus measures in his Summer Statement on 8 July. Additionally, the Bank of England announced a further £100b of asset purchases in June which will take the stock up to £745 billion, and the EY ITEM Club suspects the Bank will announce a further dose of £100 billion in November. However, the EY ITEM Club does not expect the Bank to take interest rates below their current level of 0.10%, even though it has said it is actively reviewing the case for negative interest rates.

“There should also be some pent-up demand following the overall reduction in consumer spending in the second quarter, while household purchasing power is being helped by very low inflation. Global economic activity is also now improving as other economies recover from the impact of coronavirus. This will help UK exports.

“However, many people will have lost their jobs, despite the Government’s supportive measures and many incomes will have been negatively affected. This will have some limiting impact on consumption. Indeed, the strength and sustainability of the UK‘s recovery will clearly be influenced by just how much unemployment rises over the coming months. Meanwhile, many businesses have had very difficult times and this will likely limit their willingness to invest or to commit to major new projects for some time to come.

“Although the economy is expected to achieve appreciable growth in the third quarter, the EY ITEM Club suspects the rate of expansion will slow in the fourth quarter as unemployment rises following the ending of the furlough scheme in October. The EY ITEM Club believes the unemployment rate could get up to 9.0% in late-2020 or early-2021 from 3.9% in the three months to May. Consequently, the EY ITEM Club expects GDP to contract by 11.5% over 2020 before growing 6.5% in 2021. The recovery is likely to be limited by persistent consumer caution, higher unemployment and only slowly recovering business investment.

“Furthermore, the EY ITEM Club believes there it’s unlikely the economy will regain its fourth quarter 2019 size until 2024.”

Howard Archer adds: “A downside risk to the outlook is the possibility of a significant new coronavirus wave returning later in the year, requiring restrictions to be re-imposed. Another downside risk is that even with the relaxation of restrictions on activity, consumers and businesses may remain cautious in their behaviour for an extended period. The scale of the possible impact of job losses and business difficulties – despite Government support – is also unknown.

“The EY ITEM Club 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. However, this is not certain and the possibility of trade between the UK and the EU reverting to WTO rules from next January is another risk to the 2021 outlook.”