Gerard Lyons sees a U-shape recovery with a pickup in H2
Dr Gerard Lyons, chief economic strategist at Netwealth, told IGTV’s Victoria Scholar the UK economy is likely to pick up in the second half of this year, but won’t reach pre-crisis levels until next year.
PRESENTER: The British economy will shrink by 8% this year and isn't expected to recover from the fallout from Covid-19 until 2023. At least that's according to the latest report from the EY Item Club, after official figures revealed that the UK economy shrank by a record 20.4% in April. Joining me to discuss the economic outlook is Dr Gerard Lyons. He's the chief economic strategist at NetWealth. He's on the board of the Bank of China in the UK, and he's also a senior fellow at Policy Exchange.
I think the question that everyone really wants to understand is what the shape of the recovery is going to look like. Are you an optimist, a glass half full, 'V-shape' type recovery person, or are we in a prolonged period of weakness?
UK employment will need continued stimulus
DR GERARD LYONS: I'd like to describe myself as a realist. The economy is in a deep recession, but there's no doubt that unlocking the country will bring the economy out of recession. It's likely that the economy will pick up through the second half of this year and into next. But it's difficult to predict exactly when it will get back to its pre-crisis level. My feeling is that the economy will reach the level it had at the beginning of this year by the end of next year.
The big issue is going to be what happens to jobs. We're going to see some very poor news on the unemployment front in the coming months. At the same time, we have the end of the furlough scheme this quarter, so unemployment may not get back to pre-crisis levels for a few years. The economy will recover in terms of output, it will be a good recovery in some respects. In the jobs area it is going to be far more difficult. That will require continued policy stimulus. I would expect the Bank of England (BoE) to have to keep interest rates low.
They have to inject more money. The governments should actually not only unlock, but also change some of its requirements, such as social distancing. At the same time, I think there need to be tax cuts to help the economy along with a lot of different points I want to unpick.
PRESENTER: Firstly, you mentioned the fact that the government needs to relax some of these rules including the two-metre rule, and also the 14-day quarantine. We've seen today the FTSE 100 and global markets are under pressure amid concerns about a second wave possibly coming from China. What's your assessment of the risk of a resurgence in the virus and how could that potentially obstruct the recovery?
How likely is a second wave?
DR GERARD LYONS: I did some detailed work on this with University College London. We looked at the analytical frame of epidemiological models and behaviours from economics. The reality is that when we are in the vaccine gap as we are now, there will be localised outbreaks and therefore it's very important, wherever those localised outbreaks occur, that they're contained very quickly to stop the spread of the virus.
The epidemiological models inevitably assume there is a second wave, but that need not occur. Indeed, whether it's in Britain or in China, for the next phase to work well and keep the virus under control, allowing the economy to recover, you need to have three things. You need to have testing, track and trace, and behaviours need to change. People need to behave in a very cautious way, spending more, but still cautious in terms of public hygiene and social distancing. It's likely that there will be localised outbreaks - whether this is the second wave we will have to wait and see.
A new shape of recovery
When one looks at the shape of the likely economic recovery, the markets have been debating whether it's a 'V' or a 'U' shape. I think it seems likely to be a new shape, but that risk of an 'L' or a 'W' still exists. Because of the high amounts of unemployment, the economy remains depressed. I think if we unlock in the gradual way in Britain, and if behaviours do change, then it's more likely to be a new shape of recovery.
PRESENTER: What's your view on how the chancellor has dealt with the economic fallout from Covid-19 so far, and what are some of the key fiscal measures that the government needs to take from here to support the recovery?
Fiscal stimulus doing the heavy lifting
DR GERARD LYONS: The fiscal stimulus has been significant in the UK. Initially, it was too complex, but then the Chancellor made it easier for funds to be accessed. Last week the European Central Bank (ECB) provided its global analysis of what was happening. What was remarkable there was how the UK fiscal stimulus, even though we think it's sizeable and it is, was relatively small compared to some other countries. What we've seen both in Britain and elsewhere is that the bulk of the last decade monetary policy has been the shock absorber. Interest rates have been pushed lower, central banks have seen their balance sheets increased. In this crisis while monetary policy has also been accommodating, it's being fiscal policy that's done more of the heavy lifting.
Here in the UK having eased fiscal policy the chancellor continues to remain accommodative. What do I mean by that? In an environment of low inflation, low interest rates, and low yields, there is scope for UK government borrowing to remain high. We must not have austerity and we should not have tax increases. Having done a lot so far, the Chancellor needs to continue to keep his foot on the accelerator, and then take one or two sectors of the economy.
Hospitality and leisure sectors are very important in the UK. Their business models will not be able to return to normal while social distancing exists and while there is no vaccine. Those sectors might need to have continued fiscal support, while it might be pulled away from other areas that are returning to normal.
PRESENTER: It seems as though fiscal policy has been doing the heavy lifting, and on the monetary side there's been a lot of fatigue ever since the financial crisis with ever-shrinking interest rates. What do you think the role of the BoE should be in helping to support the economic recovery and what are you expecting from the BoE?
BoE will keep the rates low
I think the backdrop is where the government needs to outline an economic vision, so that people can plan ahead. Yet in the very near term monetary and fiscal policy need to be both consistent with one another, accommodating short-term interest rates that are already very low. I personally don't think interest rates need to go negative. I'd like to see the BoE focus on pegs and rates. In terms of pegging - ten year yields close to zero - and focusing on easing macro-prudential regulations, which have not received as much scrutiny as they could have done.
PRESENTER: Let's talk about Brexit, which seems to have been slightly pushed off the agenda because of the growing of virus. Brexit nonetheless remains very much front and centre as a priority for the government. There was an interesting article this week in the Economist saying that Boris Johnson's government needs to take the option to prolong the transition because firstly, Brexit already happened in January, and secondly Britain potentially could pay less into the EU budget now that it is out of the Common Agricultural Policy. What's your response to these arguments?
Brexit: UK and EU need to reach a deal before 2021
DR GERARD LYONS: I think it's quite clear the UK needs to not extend the transition period. There's no doubt that this virus has weakened the UK economy. At the same time, this virus has also weakened many of the continent's economies, Spain, Italy, France in particular have been quite weak. What that means is that we should approach it from a sense that economically it makes complete sense for both the UK and EU to reach a deal before the end of the year.
The UK is not going to ask for a transition. Remaining in the transition leaves the UK exposed to new EU regulation and rules without us having the votes, veto or voice on those. I think we would pay more if we would stay in and extend the transition. It makes complete economic and political sense for both the UK and the EU to reach a deal. I think as the clock ticks down towards the end of the year, there will likely be a deal between both sides. Indeed, the pre-crisis economic agenda of levelling up the economy, not having the Brexit transition, and moving towards net carbon zero economy, all those important features remain in my mind very much in place even after this virus.
PRESENTER: Unilever last week decided to pick London over Rotterdam as its corporate headquarters. Alok Sharma, the business secretary, said that this was a clear vote of confidence in the UK. We also heard from the EU's chief negotiator Michel Barnier, who said that London should not be a European financial hub after Brexit. Do you think London will be able to maintain its prominent position within the financial system?
Will London remain the global financial centre?
DR GERARD LYONS: There's no doubt that London will remains the global financial centre. Indeed, it will continue to compete against New York, against new centres in East Asia. There's no doubt that in Europe, London has the dominant lead in terms of major financial centres. It's possible that one or two others may gain relatively. I think when one looks at the whole skill set here in London, it will benefit.
What London and the city need to do is to remain internationally competitive. At the same time, I think there's a strong need in the UK post virus to ensure the city continues to provide finance needed for the UK economy. There is still a massive shortfall, a funding gap for small and medium-sized firms in the UK, which last year was estimated by the officials to be £22 billion.
In terms of the City of London, it needs to continue to remain a place that's attractive for people to do business in. It's also important from a domestic UK perspective that we see more of those pools of capital being directed towards longer-term investment here in the UK.
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