What Brexit Shock?
The last few months have been a great time to brag for Brexiteers across the UK; the Article 50 bill has sailed through Parliament and reportedly will be formally triggered on 9th March, and there has been an abrupt reversal in almost all economic forecasts about the UK economy. Before the referendum, most forecasters predicted that the UK economy would be mired in recession by now, prompting Michael Gove, a leading figure in the Leave campaign, to famously assert that Britons had “had enough of experts”. For now at least, these ‘experts’ have been proved wrong and the Leave campaigners have been proved right; the key question is how long this will last.
Despite the warnings of forecasters, the UK economy continued to perform strongly in 2016 after the Brexit vote in June; the economy grew by 2% over the course of the year. Whilst this was lower than the 2.9% and 2.2% GDP growth in 2014 and 2015 respectively, it is still a solid growth rate considering there isn’t much slack left in the economy, with unemployment at just 4.8%. In August, the Bank of England predicted the UK economy would grow by 0.8% in 2017. This was revised up to 1.4% in November, and in the recent Inflation Report it was raised again to 2%, the exact same rate of growth as in 2016. All other forecasters have followed a similar pattern of raising forecasts, with most forecasts for growth in 2017 being in the range of 1.5-2%.
It is incredible that forecasters got it so wrong when you think about the impact of the referendum intuitively. The UK had experienced strong consumer spending growth for the past few years before the referendum, real wages were, and still are, rising. Most importantly, over half of the adult population were pleased with the outcome of the referendum and therefore weren’t going to spend any less than they would have done otherwise, and also a significant proportion of Remain voters, like myself, saw voting to Leave as a slightly riskier but by no means calamitous option. This resilience in consumer spending has been demonstrated as the growth in GDP in the fourth quarter of 2016 of 0.6% was almost entirely driven by consumption.
However, there are risks to this consumer spending which is driving the economy. As has been well documented, Sterling has fallen sharply against almost all major currencies since the referendum, for example falling from a high of $1.50 on the eve of the vote to around $1.25 at present. This will inevitably push up import costs, and therefore inflation is expected to pick up pace over the course of 2017. With wage inflation of just 2.4% in 2016, it is possible that inflation could outstrip wage rises over the course of 2017, which would squeeze household finances and slow the growth in consumer spending.
As consumer spending growth appears likely to drop off in the coming months, for strong levels of economic growth to be sustainable in the medium term the UK needs other components of output, such as investment and trade, to contribute more to growth. Right now, there is not a great deal of evidence of them doing so. Instead, growth remains worryingly dependent on the fragility of debt-fuelled household spending.
How investment and trade will fare depends largely on the type of Brexit deal that Theresa May is able to reach. Her rhetoric has been somewhat more pro-business and pro-globalisation than the first few months of her premiership, when she famously called members of the international elite “citizens of nowhere”. With Trump in the White House, the prospects for a post-Brexit US-UK free trade deal have brightened considerably. This, and the threat of the so-called ‘Singapore option’, whereby the UK slashes red-tape and cuts business taxes if the EU does not grant the UK a good deal, look like they will induce EU leaders to allow the UK a Canada-style free trade deal. Although this will cause economic disruption, it will be nowhere near as harmful as falling back on WTO rules would be for the UK economy.
According to PwC, UK economic growth is predicted to outpace all other G7 countries between now and 2050, with average annual growth of 1.9%. While leaving the EU is likely to exert “some medium-term drag” on the UK economy, this would be counteracted by the ability to new trade ties with “faster growing emerging economies”. PwC stressed that this growth depends on the UK remaining open to skilled immigration from across the world post-Brexit. With the more pro-business rhetoric of the Government in recent months, this is likely to be the case. For example, Phillip Hammond, Chancellor of the Exchequer, had recently described limits to highly skilled workers as “shooting our kneecaps”.
Therefore, it does appear that the prospects for the UK economy are still bright in the long run. Also, with their predictions of growth in 2017 at between 1.5% and 2%, it appears the so-called ‘experts’ are finally right. Over the next few years, before the UK formally leaves the EU, UK economic growth is likely to stay around this level. How it will fare after we have left the EU and have a new trading relationship with our largest trading partner is anyone’s guess.