Second lockdown is not inevitable

The UK is facing a further contraction in its economy unless it increases spending on supporting jobs during the second wave of Covid-19. That is the opinion of the IMF which downgraded its forecasts for UK GDP in 2020 and 2021.

The economy is now expected to contract by 10.4% this year and recover in 2021 growing by 5.8%.

In order to invigorate the economy, the IMF recommends that the Bank of England increases its support for the economy by increasing its bond purchases. Support should last as long as the rate of infections remains according to the Fund’s Managing Director.

Data for UK manufacturing and services output will be released early next week and while it is too early to be affected by the regional lockdowns that have taken place in the past few weeks, it is expected that output, although remaining in expansion, will return close to contraction.

The IMF’s downgrade in its expectations for the UK economy came as something of a surprise given that only a month ago it predicted a 9.8% contraction. The downgrade presumably reflects the effect of the second wave but also refers to the level of support provided by Chancellor Sunak in his latest package of measures.

A Government spokesman commented yesterday that a second total lockdown is not inevitable. The change in policy from last March reflects the understanding of the spread of the virus. Regional lockdowns allow areas of the country that are less affected to remain open albeit under a significant degree of caution.

Yesterday, the pound fell against the dollar due mostly to U.S. data but managed to remain close to its recent high versus the single currency (see below). It fell to a low of 1.2880, closing at 1.2929. Versus the single currency, it reached a high of 1.1103, closing at 1.1076.

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Trump to take the credit?

The front page of this morning’s Financial Times carries just about the most predictable headline it could find following yesterday’s release of the first cut of GDP data for Q3.

The U.S. economy grew by an annual rate of 33.1% in the period between July and September, following a 31.4% contraction in Q2. Both these results are records.

In an effort to bolster his election campaign, President Trump was quick to take credit for the turnaround. He commented on Social media that the GDP numbers were the biggest and best in the country’s history. He predicted that the data doesn’t come close to 2021 which will be fantastic.

There is no doubt that the data is eye popping, but the turnaround is far from complete with several States facing further partial lockdowns as cases rise to levels close to their peak earlier in the year.

With the election just a few days away, it was entirely predictable that Trump would use the data to endorse his campaign expectations but for those still facing hardship, the inability of Congress to pass a Pandemic Relief Bill to replace the support that expired at the end of July is a far more telling factor.

When delving below the headline, on a non-annualized basis, the economy shrank by 10.4% in H1 recovering by 7.4% in Q3. That means that the economy is heading in the right direction but with Q4 set to be far tougher as pent up demand falls, the country will approach 2021 with considerably more work to be done.

The FOMC which meets next week will have taken note of the data and while it is unlikely to act to provide further support yet, Jerome Powell will be aware that the Fed’s job is also far from complete and he will join his colleagues in continuing to call for support from Congress.

The dollar rallied following the data and for once three was no ambiguity about the greenback’s strength. The index rose to a high of 94.10 closing at 93.93.

Today, traders will be beginning to position themselves ahead of both the most important election in a generation as well as an FOMC meeting and the October employment report. It is impossible to predict where the dollar, or indeed the U.S. will stand at the end of next week, but indicators of volatility are likely to be much higher.

Hints at additional support in December

Europe is facing a winter of discontent as economic activity, which was faltering in its recovery is severely diminished. Total lockdowns, albeit for a period (for now) of one month will significantly affect preparations for the Holiday Season

Even if France and Germany were to completely reopen on December 1st, the hit to activity is going to be severe and likely add to the size of the annualized contraction.

The ECB meeting which took place yesterday left interest rates and bond purchasing activities unchanged. Christine Lagarde the ECB President told reporters at her press conference that the Central Bank acknowledged the worsening economic climate.

She laid the groundwork for an increase in support at the next meeting which will take place in December. The ECB, unlike the FOMC or MPC, is not able to take intra-meeting decisions; practically given the size of the General Council pragmatically given the wide range of expectations of its members.

Ms Lagarde also said that the Bank was keeping a close watch on the euro since its strength has a direct effect on inflation expectations.

Yesterday’s fall versus the dollar will have come as some relief but the analysts still fear that it is overvalued on a trade weighted basis.

In announcing that the ECB would spend the time between now and the next meeting gathering data to ensure it is well prepared for any action, Lagarde used the language that the market has come to expect

She cautioned against expecting support being given through bond purchase only. She was at pains to convince her audience that the Bank has a range of actions available to it and will decide how best to use them.

The euro fell to a low of 1.1650, closing at 1.1674 versus a resurgent dollar yesterday. The next significant support is at 1.1600 but with the volatility of the dollar set to increase, technical analysis may prove to be useless for the next few weeks.