Here We Go (again)

We are approaching the end of another calendar quarter of life passing in a fashion that still cannot be described as normal.  The longed-for return to the easing of all social and economic restrictions is delayed across the United Kingdom.  Whilst we definitely have more freedom to go about our business than we had six months ago, the current environment would have been seen as an extraordinary way of life at the start of 2020.  No matter how different things become, however, as a Scottish football fan some things remain permanent and predictable.  It may have been 23 years since the national team made it to a major football championship, but the emotional journey the fans have taken during the delayed Euro 2020 tournament is exactly the same as any we watched in the 1970s, 80s and 90s.  Excitement and expectation at the start, an abrupt introduction to reality in the early stages, but normally leaving a flicker of hope going into the last group game – which is subsequently extinguished pretty quickly.  The emotional state of mind of the Scottish football fan is summed-up perfectly by the oft used statement; The despair I can handle, it’s the hope that gets me.

In many ways, we can apply that sentiment to our expectations for a return to economic and social normality over this summer.  We are clearly at a crucial juncture in the health data.  Cases of Covid-19 are rising sharply across the UK, driven by the earlier opening up of social activities and the impact of the much more transmissible delta variant of the virus.  Without vaccines, we would almost certainly be facing another period of lockdown.  However, we do have vaccines and this has significantly weakened the relationship between cases, hospitalisations and deaths.  What we don’t know with certainty at this current point is whether it has weakened the relationship enough.  It looks encouraging, but it will be another few weeks before the evidence is more conclusive.  For what it is worth, our internal work on the progression of the pandemic suggests that the UK’s vaccine programme will allow for the full(ish) reopening of the economy in line with current government plans.

The success of the UK’s vaccine programme up to this point has fuelled upgrades to its economic growth forecasts on a sustained basis throughout the first half of this year.  The scale of these upgrades have been larger than all other major Western economies.  It is now well understood that some of the dramatic decline in UK GDP numbers last year was due to a statistical treatment of public sector activity that was not consistent with the treatment in other nations, and that this will lead to higher growth figures as these impacts reverse out.  However, there is also more generally stronger underlying momentum in economic activity.  This can be seen in various data points like PMI surveys and labour market vacancy numbers.  It can also be seen anecdotally through the trading statements of domestic business.  It is most apparent in retailers and housing-related activity, but improved trading momentum is apparent almost everywhere.  The notable exceptions remain in travel and hospitality, where uncertainty over what will open when bedevils any kind of forecasting.

If lockdown “hawks and doves” are keenly awaiting near term data on the progression of the clinical emergency, so inflation “hawks and doves” are equally at a potentially pivotal point in understanding what is going on with price levels in the economy.  In the US and the UK, inflation rates are generally higher than would be comfortable for bond markets trading at the levels they currently are.  It is easy to see the base effects of volatile commodity, energy and other prices feeding through to short term spikes in inflation.  It is less obvious what impact this short-term jump has on longer term price setting expectations.  We have seen periods like this before (most notably in 2011) and the impact abated quickly.  However, there is arguably less spare capacity in economies than at that time, and supply chains are more compromised by geopolitical issues, as well as general Covid inefficiencies.  There is a real risk that higher inflation expectations become entrenched into contract and wage negotiations.  At that point, bringing these expectations back involves higher interest rates on bonds; either through central bank action, or through higher term premia to account for even lower real rates.

We don’t believe that we are at this stage yet.  We expect medium-term inflation expectations to remain within acceptable boundaries, as short-term disruptions to supply chains are removed by dint of innovation and capital investment.  But we have to recognise that the risk exists and act accordingly.  This means directing our resources to businesses with the means of raising prices to offset cost increases, and those who will be part of the solution in making businesses’ operations more efficient.

All of this leaves us looking at the second half of the year with guarded optimism.  If the next few weeks continue to see a relatively low number of hospitalisations and deaths due to Covid, the rush to spend pent up savings is likely to intensify.  If overseas territories remain wary of UK visitors because their vaccine programmes are less well advanced, then domestic businesses could see an even greater improvement in trading.  Specifically in the UK, people’s relationship with their houses is changing dramatically, with many now likely to spend much more time working from home even after the pandemic has fully receded.  This will keep the housing market buoyant and stimulate new construction – both critical components of wider economic confidence in the country.

Indeed, even the England football team suffering a penalty shoot-out loss to the Germans in the impending Euro Championship game would not be enough to dent confidence.  For the sake of all our friends south of the border, we hope that in tomorrow’s game the English can break the shackles of recent football history a lot better than the Scots.  We’ll be cheering on from the sidelines.

Written by Glen Nimmo