The UK’s “relatively robust” recovery could be put in danger by three key issues as the economy starts to normalise following the Covid-19 pandemic, according to Royal London Asset Management’s Melanie Baker. 
Baker (pictured), senior economist at Royal London Asset Management, said the global economic recovery will be sensitive to a second wave of coronavirus until a vaccine is developed.
“This remains a highly unusual recession. After a deep, quick fall, the global economy is now in the recovery phase, but patterns and levels of activity remain far from normal,” she said.
“The forecasts still show a path to full recovery taking significantly longer than the slump, despite the rapid and sizeable economic policy support being implemented.”
As such, the outlook remains uncertain as the coronavirus continues to circulate.
After shrinking by a “breathtakingly awful” 20.4 per cent during the second quarter, the UK economy has started to show signs of stronger growth as people have begun returning to work, said Baker.
Indeed, economic data suggests that the UK recovery is “well underway and relatively robust”, according to the RLAM economist.
Nevertheless, there are three key issues that suggest it could slow soon: social distancing, ‘scarring’, and fear.
On the first key issue, Baker said although social distancing has been slowly relaxed since late-May, Covid numbers have picked up since late-July when conditions began to normalise. She said the UK may be close to the limit of reopening until a vaccine becomes available.
“It seems unlikely at this point that the UK will see nationwide lockdowns again,” she said. “However, social distancing measures remain in place and the government have demonstrated a willingness to impose local lockdowns.”
On ‘scarring’, Baker said the UK government had done a good job of limiting the impact of the coronavirus on the economy, particularly with regard to permanent job losses via the furlough scheme.
However, she warned that the labour market and business finances have seen “significant disruption”.
Despite the furlough scheme, PAYE (pay-as-you-earn) data to early-July suggested the number of workers on business payrolls was down by 730,000 since March.
In addition, businesses have made heavy use of government support schemes, including the furlough scheme. And there has been some high-profile companies going into administration or cutting jobs.
“Ongoing policy support is still needed while business conditions are far from normal if future growth potential is going to be preserved,” she said.
Finally, the residual fear of the virus could have a chilling effect on the UK recovery and is likely to depend on developments for a vaccine and in the policy space.
“Virus fears extend to worries about localised lockdowns and how those could affect businesses and job security,” Baker explained. “Policy decisions around economic policy support as well as health therefore matter.
“Hiring, investment and consumption decisions are all likely to be affected (dampened) by relatively significant levels of Covid-related fear.”
She continued: “The forecasts continue to assume that the level of residual fear will remain high until there are more effective treatments or a widely available vaccine.”
There are still things that the government can do to assuage markets and investors, though, according to Baker.
While support from the Bank of England and initiatives by the UK government have helped limit the impact of Covid-19 or bring forward activity (such as the ‘Eat out to help out’ and furlough schemes), they are about to wind down.
Baker said without a vaccine, the UK economy is likely to remain smaller in October – when the furlough scheme ends – than it was before the pandemic.
“Government plans seem predicated on the UK moving firmly out of economic crisis,” she explained. “But the shape of recovery is very uncertain.”
While the Bank of England has helped contain government funding costs it is now buying back gilts at a slower pace than at the start of the crisis, but it doesn’t have to, said Baker.
Likewise, while there will be some kind of ‘fiscal reckoning’ – with government debt as a percentage of GDP set to soar – it doesn’t have to happen yet.
“Chancellor Rishi Sunak has already said that there are tough choices ahead,” said Baker. “Tax rises seem inevitable at some point in the next five years, alongside some departmental spending cuts. However, fiscal tightening – other than the unwind of support schemes no longer needed – should be held back for the later years of the fiscal plans.
“Despite higher debts and deficits, markets are still willing to lend cheaply to developed economy governments.”
The spectre of Brexit also continues to hang over the UK economy, with many businesses growing increasingly concerned about exiting the bloc without a trade agreement and weighing heavy on investment.
However, Baker said a deal is its central case with both sides likely to come under intense pressure to agree on something.
“The central case assumes that when the transition period ends on 31 December, there are arrangements in place – likely including a ‘thin’ trade deal – so that the UK and EU do not default to WTO [World Trade Organisation] arrangements,” she said.
“In the central case, Q4 growth is boosted by households and firms bringing forward activity ahead of possible disruption.”
As such, next year is likely to get off to a slow start, which will be exacerbated by any assumed logistical problems at the borders.
“Over several years, growth is dampened by the costs of adjusting to new trading arrangements and red tape; by some forms of trade no longer being viable/profitable; and a tighter immigration regime,” Baker explained.
A ‘no deal’ Brexit would be a sizeable hit to the economy, she added, noting that the UK would face the EU’s external tariffs making imports would generally be more expensive.