UK bounces out of recession in Q3 2020

JaeVee Team

22 minutes

Introduction

The UK economy was at its lowest level for decades in the first 6 months of 2020 as a result of Covid-19. With a national lockdown in the first two quarters preventing people from going out and spending, and with many sectors having to close for this time period, it was no surprise that the UK economy was going to significantly shrink.

However the UK government has used both fiscal and monetary policies to try and control this damage and from the latest Q3 results, it appears to be working as the UK has bounced out of recession.

In order to first understand what this means, we must first understand what a recession is and how this particular recession was caused. We will then look at how the UK managed to bounce back from this recession in such a short period of time and what the future outlook may be on the UK economy with views on how a second lockdown and a possible vaccine may affect the UK economy.


What is a recession and how is one caused?

A recession is simply defined as a period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters.

In this case, UK GDP contracted by 2.5% in Q1 2020 and then a further contraction in Q2 2020 of an unprecedented 19.8% saw the UK go into a technical recession. The first answer you may think of when it comes to what caused this recession may appear to be obvious, Covid-19. Whilst this is true, we can look deeper into how Covid-19 has caused mass layoffs across the country and why large firms appear to be going bankrupt on an almost daily basis.

The first and perhaps biggest reason why the UK economy shrank by such a record figure is because of the first lockdown that came to the UK. The first lockdown was announced towards the end of March and meant that everyone with the exception of key workers, had to self isolate at home. This meant that many workers who were unable to work from home, had to stop working and the companies they worked for also had to close their doors.


Due to certain sectors not being able to work from home, such as retail and hospitality, it meant that this recession was not caused by a general decrease in all sectors of the economy like you might expect.

Instead it can be considered a recession caused by particular sectors which ultimately had a knock on effect to the rest of the economy. In the case of the retail and hospitality sector, it meant that many companies had to close which meant they could no longer sell their products which, as mentioned, has been a massive contributor to the recession. However, because these companies have had to close their doors, they are losing money due to fixed costs and so have had to make staff members redundant.

In this case, it means that those workers who have been made redundant no longer have the capital to go out and buy products which is where we see the knock on effect. Because those who work in sectors that were most affected by Covid-19 lost their jobs, it means that other sectors where consumers would usually spend money also suffered as those consumers no longer have the money to spend on luxury items. These two factors have largely contributed to causing the UK economy to go into recession for the first two quarters of 2020.

The other large factor that caused a recession as a result of the lockdown, was not the fact that consumers didn’t have money to spend, but the fact that access to spending was limited. By this, we mean that consumers had to stay at home in lockdown for months meaning they physically could not go out and spend money. Their only options for spending were either through online shopping (such as Amazon) or purchasing goods at their local supermarket. This therefore heavily restricted the types of products consumers could purchase. Because less of these items were being purchased, it meant that the companies that produced them were making less income but still had fixed costs to pay for, they therefore looked to reduce their spending which resulted in redundancies being made.

This had a knock on effect for those workers who did lose their jobs as they now have less income which is the same theory described earlier. We consider this different to all other recessions as there has never been a time when consumers were physically restricted from spending money. Throughout history, a recession has always usually been caused by factors such as our first example where people have lost their jobs in a particular sector or more generally across the whole economy and are therefore unable to purchase their usual basket of goods since they can’t afford to.

However, in this instance, many consumers still have their jobs and are still earning income, but they can't physically go out and spend their money which means less goods and services are being bought and sold which ultimately drives economic performance.


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Why was this recession so short compared to other recessions?

As described in the point above, this recession wasn’t so much about mass unemployment and economic downturn in terms of lots of companies going bankrupt. On the contrary, it was about consumers being physically restricted from spending money.

A classic method for how to get a country out of recession is to reinstate confidence in the economy to encourage consumers to spend money, the more money that is spent means a faster recovery of the economy. While this has its drawbacks in terms of inflation dramatically increasing, it can be controlled in the future using contractionary monetary policy.

It appears the government has been adopting this strategy of getting consumers out after lockdown 1.0 to spend money, this can be reflected in the policies they have been using. A good example of this is the “Eat Out to Help Out” scheme where the government would cover some of the cost of a meal. This was a big success in terms of the economy and saw the struggling hospitality sector thrive in August and gave them a much needed boost in their income after months of being forced to close their doors.

It was as a result of these types of policies why spending was so high once lockdown ended and what caused the UK to see record economic growth in the third quarter of 2020.

As you can see from the quarter on quarter growth chart, the UK experienced negative growth of 2.5% and 19.8% in the first two quarters of 2020. While this contraction was unprecedented, you can also see that the third quarter was also unprecedented in terms of growth for the UK economy with a 15.5% growth rate.

As previously expressed, the reason why there was such a large increase in economic growth was partly due to the government and the policies they introduced, as well as the fact that consumers have gone out and spent money which they were able to save during the lockdown period.


What is important to remember about this recession is that it was not like any other recession. Usually a recession is caused because of a downturn which causes unemployment to skyrocket and production to decrease. However in this case, the economy hasn’t experienced a major downturn, it has more so just paused for a few months. While this has caused cash strapped companies to go bankrupt and for unemployment to rise, the vast majority of companies and workers have been able to survive the tough economic pause.

This has meant that once the lockdown was lifted, all of these companies and workers could go back to work and start spending their money again, in some instances some consumers have actually been spending more money than before Covid-19 as they were previously unable to spend anything during the lockdown period.

Of course it must be noted that the UK economy isn’t back to its pre-covid level just yet. Whilst the majority of the UK has been able to turn back on production and spending after the lockdown, there are some workers who have lost their jobs and companies which have gone bankrupt. This is reflected when looking at the GDP level pre-covid and post-covid.

As you can see from the chart above, the UK has bounced back from recession. We are still not at the pre-covid level however. While this is partly due to the job losses and bankruptcies that have occurred, it must also be noted that we only have one quarter of growth so far. The recession and unprecedented decrease in the economy was caused over two quarters, therefore it would not be fair to compare a two quarter decline with a one quarter growth.

It would therefore be sensible to compare the post lockdown growth after the results of quarter four 2020 have been published to see how far off the UK is to its pre-covid level. While it is unlikely that the UK economy will make a full recovery in that time, we may see consumers spending more than before lockdown and companies producing more. The damage therefore might not be as bad as first thought due to the consumers spending more money and ultimately getting the UK economy back on track.


How will the UK economy react to the second lockdown and news of a vaccine being found?

While the UK has been on an upwards trend for the last 3 months, it is important to remember that we are still below pre-covid levels in terms of economic performance. Therefore we are not out of the woods just yet.

Furthermore, the rollout of a second lockdown has caused many businesses to close their doors again giving huge pressure to companies to keep their heads above the water. Whilst this lockdown 2.0 has caused many businesses to close their doors again, more businesses are continuing to operate as normal even under lockdown restrictions.

During the first lockdown there was less information available about the virus which caused many businesses and individuals to rightfully be overcautious. However, as we are now more informed about not only the virus but also about the restrictions the government has put in place, many people can continue going to work during the lockdown in a safe manner. This means that the economic decline experienced during the first lockdown isn’t likely to be replicated for this second lockdown as more people are now working and companies continue to operate in a somewhat normal fashion.

Furthermore, while the month of November is likely to experience a decline in economic activity as a result of this lockdown, it must be noted that the fourth quarter is also defined by economic activity in October and December. October is likely to carry on the momentum seen in the Q3 2020 results as consumers continued to go out and spend money. We should also see an increase in economic activity in December as many will be purchasing goods and services in the run up to Christmas.

This positive trend in economic activity may be bolstered further by the fact that several vaccines have been found and are now undergoing regulatory proceedings so they can be rolled out across the country. While it may seem that a vaccine won’t have much difference to the economy if everyone is already out and going to work, it is important to understand the main mechanism that drives an economy - namely certainty.

While Covid-19 is still at large across the county, there is still lots of uncertainty surrounding the economy as there will always be a risk that another lockdown would need to occur. Therefore, during these times, many people are uncertain about the future and as such, tend to hold off on making financial decisions. An example may be that someone has saved to buy a new house, though as a result of Covid-19 causing uncertainty, said person may have been put off buying a house with fears that they may lose their job and would need those savings to instead buy essential items.

Now that a vaccine has been found, there is certainty towards the future which will only have a positive impact on how individuals and companies approach their decision making. This should result in financial markets strengthening as well as investments in other areas such as property increasing in activity.


What does this mean for the UK property market?

The UK property market has been a backbone for the UK throughout this tough time. While there was speculation that the market would plummet during the first lockdown, it was actually found that the market simply “pressed pause” as it wasn’t realistic for most consumers to move house during that time.

Now that the lockdown has been lifted, we find that many consumers are now looking to move house. With the introduction of the stamp duty holiday, we have seen increased activity in more people taking the opportunity to move house. Many people are either looking to make a saving on the purchase of a new property by taking advantage of the stamp duty relief or simply just wanting to move into a bigger house.

With most people now working from home, they are spending more time in their homes and therefore want a nicer place to live. The introduction of home working being rolled out for many companies could actually result in more demand for properties due to the fact that people are spending more time at home. With an increase in demand for properties, it can only result in the market strengthening further.

In terms of how a vaccine will affect the UK property market, we should see a similar pattern to how financial markets would react. As mentioned earlier, the news of a vaccine being found gives confidence not only to consumers but also to companies. This means that more consumers will see moving house as an achievable goal instead of saving their extra money in the event they lose their job. Similarly, we should see more investment into the property sector.

Not only will we see investment from investors who are now more confident to spend their money, we will also see alternative investment come in from investors who don’t usually invest in property. The reason why new investors may decide to now invest in UK property is because of how it has performed during the pandemic. As previously mentioned, the property market has remained relatively stable with house prices continuing to increase.

The future outlook for the UK property market appears to be positive, with the UK now out of recession it appears that the majority of the UK economy is back up and running. It is a well known fact that when the rest of the UK economy is performing well, the property market reflects this as people are earning more money and wanting to either get on the housing ladder or live in a nicer home.

While a second lockdown may give speculators a reason to say that property prices will go down, we can actually use data from the first lockdown to confirm that house prices shouldn’t be affected by the second lockdown and that if anything, they will continue to increase. Looking at the average house price in the United Kingdom, we can see that the average house price in September 2020 was £244,513, yet one year earlier the average house price was £233,536 representing a 4.7% increase over 12 months.

We should also expect to see property prices increase over this period since buyers who purchase a property before the end of March 2021 can qualify for paying zero stamp duty which makes buying a home more desirable until March.

Finally, with a vaccine being found, we should expect for there to be far more confidence in the property market, both from home owners and investors. This therefore suggests that property prices will continue to increase and that property in the UK will continue to be a good investment.

About JaeVee

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