By Matthias Busuttil
The stronger than expected rebound in economic activity since April is beginning to stutter as the resurgence in virus cases across major economic regions has led to the reintroduction of restrictive measures and partial lockdowns with the aim of curbing the contagion.
The sharp contraction in economic output recorded in the second quarter across advanced economies was primarily driven by sudden declines in consumption. However, more recent economic activity data, particularly the rebound in retail sales, saw surprising rates of recovery in the level of sales and consumer spending which generally outpaced consensus expectations.
What seemed to underpin the return in spending has been the pent-up demand following several weeks of lockdown and the contributions of governments to households which boosted personal income and savings rates during this period. More importantly, the latter has provided a solid springboard for spending to bounce back when economies reopened and acted as a counteracting force to precautionary consumer behaviour.
On the other hand, industrial production and manufacturing output was somewhat lagging the recovery as production plants took longer to reopen or operated at lower capacity utilisation levels. Moreover, retailers have been cautious in replenishing inventories given the severe business and demand outlook. It is becoming more widely reported that inventory levels have dwindled. In fact, survey-based indices, namely the Purchasing Managers Indices (PMI) flash estimates which have just been released for September, show that new orders have been growing at a notably fast rate. As a result, the manufacturing sector is expected to continue to recover and grow in the near term.
The services sector, on the other hand, is naturally experiencing greater challenges to see a sustained recovery path. Apart from such industries being the most directly affected by the crisis, the enforcement of social distancing measures remains the main drag on consumer-facing businesses. Services PMI flash estimates in fact point towards another downturn in service sector activity in the Euro area and slower rates of expansion in the US and UK than those reported in previous months.
Nevertheless, the interim economic data is overall pointing towards a strong rate of growth in economic output during the third quarter as the sharp drop in consumption in Q2 is expected to partially reverse. Consensus forecasts for GDP growth rates in 2020 and 2021 have been generally held constant or in some cases revised upwards as analysts extrapolated off the relatively positive experience in the first few months of the recovery.
However, the resurgence in cases, specifically across most parts of Europe and the UK, is leading to renewed concerns on the possibility of a double-dip recession brought about by the reimposition of lockdown measures. Despite the improved testing capabilities and the timelier deployment of containment measures, the fact that the ongoing pandemic remains a major health concern underscores the fragility of the economic rebound.
The copious fiscal initiatives have so far been crucial to support business and consumer sentiment to the extent possible, and, more importantly, to sustain job retention rates particularly in the Euro Area and the UK. However, governments are expected to run considerably high deficits to finance these initiatives and sustaining such spending for longer becomes increasingly harder given the larger debt burden on public finances. The risk is that the fallout in unemployment can be much harder, or more structural, if economic conditions do not recover and governments are required to withdraw their support. On the other hand, the ultra-accommodative monetary policy adopted by major central banks has ensured easy financing conditions and ample liquidity to facilitate the flow of credit to corporates, (and governments) in order to boost their liquidity levels and avoid running into cash flow shortages.
The reimposition of containment measures is expected to slow down the pace of the recovery with parts of the economy expected to experience contraction once again. Whilst many forecasters have adopted models that assume a one-time shock and a gradual recovery with various assumptions around the path to normality, the adoption of multi-round models is gaining popularity. As the range of outcomes widens with the increase in uncertainty, the possibility of downward revisions in growth forecasts increases. In the absence of material advancements in the development of a vaccine, the highly anticipated growth trajectory and improving economic and business conditions in Q4 2020 and 2021 will come into question.
The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.