The UK economy has begun 2017 in fairly rude health. The Office for National Statistics estimates that GDP grew by 0.6 per cent in the final three months of 2016, just the same as in each of the second and third quarters of the year. The first three months of 2016 had seen only 0.3 per cent growth, so overall growth for the year was 2 per cent, a little slower than 2015 but faster than, say, 2013.
Unemployment, meanwhile, was down to 4.8 per cent in the most recent data, a figure only bettered, since 1975, for a few months in 2004/5. Inflation was at 1.6 per cent in 2016 – a little below its 2 per cent target, but closer than it has been for years.
Yet even as the forecasters grudgingly admit that things are ticking along pretty nicely (who’d have thought we’d ever actually get bored with headlines about Britain being the fastest-growing G7 economy, or about pessimistic experts revising their forecasts upwards?), they still sound warnings of doom. Like winter in Game of Thrones, they insist, Brexit is coming – and sooner than we think.
Only a couple of weeks ago, the World Bank forecast that UK growth for 2017 would be 1.2 per cent, implying quarterly contractions from April onwards for the whole rest of the year. A few weeks earlier, the British Chambers of Commerce predicted 1.1 per cent. Yesterday, Sir Charlie Bean (the economist who signed off the Treasury’s Brexit forecasts) said he expected a “significant slowdown” in 2017.
So, is growth really about to slacken so much? Actually, I’m sceptical. Broad money growth for 2016 was above 7 per cent – a figure not seen since before the financial crisis. Such an acceleration would normally prefigure an acceleration in GDP, too.
Another reason one might think 2017 will see faster GDP growth is that, up to this point, the economy has mainly experienced the downside of the large depreciation in sterling that took place from late 2015 onwards (by about 12 per cent on a trade-weighted basis from August 2015 to its pre-referendum low in April 2016, and then a further 7 per cent since).
When currencies depreciate, the initial impact is to make things one had already committed to importing more expensive, while getting less, in sterling terms, for the same volume of exports.
So the initial impact of a sterling depreciation will be to make the balance of trade worse — with imports going up and exports down.
Only later, as prices adjust and we start to import less and export more, do we get into the beneficial phase. That can be a good nine months or more after the initial plunge occurs. (This pattern, of an initial dip followed by a later gain, is so common as to have its own name: the “J-curve”.)
The ONS tells us that there has so far been little to no boost to net exports from sterling’s depreciation. So we can expect that it is still to come. Doubly so, since growth within the countries we send most of our exports to is at its highest for 10 years.
The fly in the ointment here, which the forecasters alluded to this week, is inflation. That is rising across Europe – and Britain won’t escape.
In France, inflation on the common EU “HICP” basis was negative in the year to April 2016: i.e. prices were falling. By January 2017, they were rising by 1.4 per cent on an annual basis. It was the same story in Germany, which went from falling prices to 1.9 per cent inflation over that same period.
Recent surveys of firms suggest some of the strongest rises in input costs for many years. So inflation is likely to go above target this year – even if it is not, as many have suggested, an exclusively British, Brexit-driven phenomenon resulting from the falling pound.
Might the Bank of England raise interest rates in response? We should not entirely rule that out. The Federal Reserve has already started raising rates and will probably do so a few more times in 2017.
If the Bank of England had not cut rates in August 2016, in a panicky moment following some misleadingly negative data that came out in the confused and emotional aftermath of the referendum, there would probably be pressure to raise rates now.
It is, in fact, almost entirely within the Bank of England’s power to prevent inflation materially overshooting its target. After all, an important part of the rise in inflation is the rise in import prices because of sterling’s depreciation. If rates went up, so would the pound, reversing the import price rise. Above-target inflation, in other words, is a choice, not a curse.
In any event, I’m doubtful the Bank would make that choice until inflation actually exceeds 3 per cent – and even then, it would think very carefully about it. The MPC has not shown any real interest in meeting its inflation target since it first missed the mark back in 2006/7, and no Chancellor has ever admonished it. Why would they start caring now?
None of this is to suggest that Britain is about to experience a sudden boom. Yes, the impact of rising import prices on consumption should be more than offset by rising exports in 2017 — that’s the good bit of the J-curve.
But whether inflation bites, or rates go up, I am doubtful that we should expect 2017 to significantly outperform 2016, despite the fairly rosy international environment. Brexit really is coming, even if it’s unlikely to bring economic White Walkers, and in the latter part of 2017, I’d expect to see some transitional costs, albeit temporary, as firms begin to adjust.
There may be some investment delays, and some firms and their staff may move. Not on any vast or particularly disruptive scale – but just enough, in combination with rising inflation, to take the edge off what might otherwise be quite a strong year (especially if rate rises in early 2018 start to be priced in).
The previously more pessimistic NIESR has this week upgraded its forecast for UK growth in 2017 to 1.7 per cent from a meagre 1.4 per cent. I’ve similarly upgraded my 2017 view – from 1.7 per cent I’d been predicting for most of the time since the referendum to just short of 2 per cent (1.9 per cent).
That’s actually fairly pessimistic for the second half of the year — it means GDP growing at 0.5 per cent in the first three months, then 0.4 per cent in the next three, then just 0.3 per cent in each of the quarters of the second half of the year — and maybe I’ll feel silly by how far I undershoot. But it’s already so far above the City consensus that I’ll content myself with it for now.
Economic forecasts are always hostage to events. Lots of things could go wrong. Le Pen could win in France and the euro could collapse. Trump’s tariffs could come in quicker and be higher than I expect. China’s shadow banks could finally blow up, as everyone has warned for years.
But we could also find that Japan finally starts out-performing, the eurozone accelerates further, and new inventions take off to everyone’s benefit.
Whatever happens, the “year long DIY recession” that many warned Brexit would bring looks further away than ever.
