The UK faces escalating political and policy uncertainty at a time when the economy is already slowing and thus vulnerable. Although the UK economy grew strongly in Q3 it slowed during the quarter, and weak October retail sales and sluggish monetary growth suggest softness at the start of Q4.
It is hard to quantify the impact of current political uncertainty but it is likely to weigh on spending plans and investment intentions. Business focus has switched from the recent Budget (which was well received) to Brexit, policy options and politics.
The outcome of uncertainty is… uncertain
The recent release of the Withdrawal Agreement and outline of the future relationship between the UK and EU has already triggered intense debate, with a Parliamentary vote in December. It is premature to try and predict the outcome, which will be impacted by many features, notably raw Parliamentary politics and a focus on the future legal constraints that form part of the Withdrawal Agreement and whether there will be clarity about how much preparation has taken place for No Deal. The uncertainty generated by this outcome could yet weaken the economy further.
The picture on the Continent is similarly uncertain, with increased political tensions in Germany and in terms of the relationship between Italy and Brussels. Growth is weak, too. In a recent speech the head of the European Central Bank, Mr Draghi, highlighted the challenge:
“Since 1975 there have been five periods of rising GDP in the euro area. The average duration from trough to peak is 31 quarters, with GDP increasing by 21% over that period. The current expansion in the euro area, however, has lasted just 22 quarters and GDP is only around 10% above the trough. In contrast, the expansion in the United States has lasted 37 quarters, and GDP has risen by 21%.”
Conversely, US strength is also causing issues
Indeed, while the UK and euro area are soft, it is that strength in the US economy that is the focus of market sentiment. While central banks eased policy together in the weak aftermath of the global financial crisis, domestic factors are driving exit strategies from cheap money policies, with the US Federal Reserve leading the way.
So far, their actions have been gradual and largely predictable. Despite that, higher rates appear to be taking their toll on the markets. One more hike looks likely this year, and a couple more in 2019, leading rates to then peak.
The impact on the dollar has been to keep it firm, and while the US yield curve is flat, the continuation of cheap money policies at the European Central Bank (ECB) and Bank of Japan (BOJ) is playing its part, as money has flowed to the US.
Thus, when the ECB or BOJ tighten, possibly next year, it may have a global impact, in the same way in which higher US rates and a firmer dollar has taken its toll on market performance in a number of emerging economies. This has been exacerbated by the US-China trade dispute. Also, China has eased policy to alleviate economic worries there.
Mixed messages, but many indicators still solid
While the net result of all this points to slower global growth it is as yet unclear whether the outturn will be far weaker than markets currently expect. Various Purchasing Managers’ Indexes (which provide a good barometer of the health of the manufacturing and service sectors) point to a significant slowdown and, in addition, oil prices are softer. Against this, labour markets in advanced economies are tight, wages are rising, corporate balance sheets have helped investment plans, and the US economy is solid.
While the IMF did cut global growth forecasts at the October meetings, from 3.9% to 3.7% for this year and next, this is still steady. Meanwhile, world trade growth has decelerated, from 5.2% in 2017 to a still solid 4.6% in the first half of 2018.
In the present macro-climate it is important to have an open mind to many different scenarios, including much higher inflation than the market expects (as wages rise), or even a sharper slowdown (given recent data in the euro area and UK) and trade tensions.
While there is a need to be prepared for further uncertainty, recent market developments, including a sell-off in global equities, have also reinforced the need to take a long-term view. This is particularly relevant when one considers the present economic and political climate, too, which is adding to near-term uncertainty, especially in the UK and euro area.
We are still positive about the longer-term outlook for global growth – for reasons which include the fourth industrial revolution, the strength of the Indo-Pacific region and future macro-economic stability.
Current uncertainty and volatility does not detract from that, even though it looks likely to continue.
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