Due to the detrimental impacts of Coronavirus on business confidence and liquidity, the Bank of England recently revitalised its Quantitative Easing programme, with the purchasing of UK gilts thus expanding its balance sheet by £650 billion. This has resulted in wider credit spreads, with the UK 10-Year gilt yield falling to as low as 0.2%. On top of this, the government is expected to back hundreds of billions in business loans, whilst the central bank cut interest rates to 0.1% – their lowest ever level. Perhaps more importantly, greater emphasis will be placed on Andrew Bailey’s ability to offer forward guidance to reassure firms and investors alike.
But the lower borrowing costs and enhanced cash flows UK businesses may be facing from this programme are very much centred around the short term. With consumer confidence still weakened from the Brexit referendum, the contraction in Q2 GDP is likely to be much worse than was previously expected. The decline in sales and suppressed capital markets, has resulted in greater provisions for potential credit losses, and is likely to eat into any liquidity provision and divert funds away from much needed investment.
The warnings signs have already been showing in many sectors. Following the slump in oil prices due to a sharp decline in global demand and a supply-side shock, energy companies are some of the worst hit, with Royal Dutch Shell axing its dividend for the first time since WW2. Furthermore, the impact of Covid-19 has accentuated the decline of retail sales. With many stores ceasing trading, the monthly growth rate of sales volume in March 2020 fell to -5.1%. As well as loose monetary policy, other stimulative measures may need to be deployed to ensure businesses survive.
Although the direct correlation between economic performance and the stock market can be questioned, the significant reduction in trading volume and business confidence has damaged equity returns. Both the S&P 500 and FTSE 100 indexes have been seriously affected, with the latter falling from record highs near 7500s throughout February to 4,993 on 23 March – way below pre-financial crisis levels. On the contrary, the S&P 500 index has regained a high portion of its former value, whereas the recovery of the FTSE has been less than significant. While long-term investor sentiment may be bullish, a restructuring of the UK economy will likely need to take place before equities can reach pre-Covid levels.
The lack of substantial recovery in the UK stock market has emphasised its under-performance. All too often, the greater performance and liquidity of the US markets over the past decade has heightened their attractiveness to investors. Meanwhile the FTSE, which primarily consists of utility, banking and energy firms, has suffered from a chronic productivity problem since 2010, which has sent growth rates plummeting. It is thought that around 8-12% of UK firms display “zombie-like symptoms” and have only managed to survive due to the extraordinarily low interest rate environment (Williamson, 2019). With quarterly earnings expected to take a big hit over the next 6 months, it will be interesting to see how long such liquidity will last and what direction the stock market will decide to go in the upcoming months.
- Williamson, R (2019) “‘Zombies’ are a major drag on UK Economy – KPMG analysis” https://home.kpmg/uk/en/home/media/press-releases/2019/05/zombies-are-a-major-drag-on-the-uk-economy-kpmg-analysis.html
- Stock price data sourced from Refinitiv
- Image source: ONS – monthy business survey