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A personal view from Ian Stewart, Deloitte’s Chief Economist in the UK. Subscribe to & view previous editions at http://blogs.deloitte.co.uk/mondaybriefing/
UK growth has softened since the EU referendum, and at a time when the rest of the global economy is picking up. The pace of UK activity has not closely followed the news flow on Brexit, illustrating how politics is one of many factors influencing growth. After a poor first half the pace of UK GDP growth picked up in the second half of last year, even though the government lost its Parliamentary majority and the final destination for the Brexit process remained unclear.
Overall the UK posted GDP growth of 1.9% in 2016, the year of the referendum, and 1.8% in 2017, down from 2.4% in 2015. Though better than had been expected by forecasters, last year’s performance left UK activity slowing, albeit marginally, into a global recovery.
Brexit has had two negative effects, with higher inflation, stemming from sterling weakness, squeezing consumer spending power and uncertainty weighing on business sentiment. The downturn in consumer activity has been the swing factor behind slower overall activity. Growth in car sales, retail sales and mortgage approvals softened last year. The effects on growth were partially offset by a little-noticed acceleration in growth in manufacturing output, investment and exports.
Economists expect UK growth to slow more sharply this year. On average they see UK GDP growth coming in at 1.4% in 2018, down from last year’s 1.8%.
Brexit is the principle reason for the expected downturn. Most forecasters see risks to confidence, investment and wage growth from the Brexit process. The general view is that the consumer will continue to be constrained by weak wage growth. Moreover, while levels of consumer debt to GDP are well below pre-crisis levels, they have been rising, buoyed by double-digit growth in unsecured lending. The Bank of England worries this could weaken the resilience of the banking sector and banks have been pulling back from unsecured lending.
Poor productivity adds a further downside risk. In the last six years productivity growth has run at less than one fifth the level seen in the decade before the financial crisis. The persistence of low productivity has convinced the UK’s official forecaster, the Office for Budget Responsibility (OBR) that it is here to stay. The OBR has almost halved its estimate for long-term productivity growth, to 1.2%. This, in turn, has reduced the OBR’s forecast for trend GDP growth by a quarter.
Finally, the UK political scene has become more unpredictable. Since the government lost its Parliamentary majority last June the Labour Party has been ahead of the Conservatives in the opinion polls. In the first six polls conducted this year support for Labour has averaged 42% against 40% for the Conservatives, a reversal from April last year when the Conservatives lead over Labour averaged 19 percentage points. Jeremy Corbyn is now the favourite to succeed Mrs May as the next prime minister, with markets assigning a 25% probability to the event.
Yet for all the uncertainties there are reasons for thinking that UK GDP growth could do a bit better this year than the 1.4% expected by the average of economists.
First among them is the improving global backdrop driven by better prospects in Japan, emerging market economies and, in particular, the euro area. The global recovery is the key to offsetting domestic UK weaknesses, a point made recently by Lord Jim O’Neill, the former Goldman Sachs chief economist and Conservative Treasury minister. Lord O’Neill, a supporter of UK membership of the EU, argued that an accelerating global economy is likely to be more important to UK growth this year than Brexit, though he also cautioned that the UK could be doing even better were it not for Brexit.
Stronger global growth and a weaker pound have already bolstered UK exports, which grew by over 8% in the year to Q3 2017, five times faster than the growth of the whole economy. Last week the CBI reported that small and medium sized manufacturers are more optimistic about export prospects than at any time since survey data began in 1988.
So far wage pressures have defied economic theory, proving surprisingly weak in the face of declining unemployment. This may be about to change. The unemployment rate stands at a 42-year low and the number of people in work has reached a record high. Crucially, the rise in employment over the past 12 months has been driven by full-time work. Growth in in self-employment, which is often seen as sign as a sign of increasing spare capacity in the labour market, has softened. The number of job vacancies are at record levels and many employers are reporting skills shortages. I am inclined to agree with the Bank of England’s Michael Saunders, who sits on the Bank’s monetary policy committee, who has said that pay growth is likely to pick up this year as lower migration compounds existing recruitment difficulties.
Consumer debt is a potential risk for the UK, but one that will probably not crystallise this year. Most debt is held by households with above average incomes, and half by households with enough assets to clear their liabilities. While the Bank of England has begun the process of raising rates from their historic lows, monetary policy is likely to remain accommodative for a long time to come. Financial markets are pricing in roughly one 25bp rate hike in 2018 and a further 25bp in 2019. Such an outcome would leave the Bank’s base rate at 1.0% in two years’ time.
It is easier to think of things that will go wrong with Brexit, than right. But it seems plausible that by October the UK and the EU will agree some sort of deal to largely maintain the status quo during an extended period of negotiations. This would be consistent with the UK government’s desire to avoid two major sets of change for business, one at the time of the UK’s departure from the EU next March, and one with the implementation of the final settlement, from late 2020. Such an outcome would mean a ‘stand still’ on many practical aspects of UK membership of the EU between 29th March 2019 and the scheduled end of negotiations in December 2020. This would prolong the status quo for business – albeit leaving open the nature of the UK’s future relationship with the EU.
The outlook for UK growth this year is hardly stellar. But amid a global upturn our hunch is that it may turn out to be rather better than generally expected.