My Response to the FT’s Economic Forecasting Survey

New year forecasts, it appears, according to the media, have already started to be revised in the US in the wake of recent market turmoil. And that is within the first week of the new year! As things stand, we have not changed our thinking, but the recent market turmoil in the US reflects one of the key issues we have highlighted for some time: the challenges of monetary policy tightening, and the sensitivity of both financial markets and economies to such tightening.

Before Christmas, my colleague Iain Barnes, and I, provided some year-ahead views, highlighting the key issues to come. These comments can be accessed here and here.

Meanwhile, in their annual forecasts from economists – which you can read in full here – the questions from the FT focused on Brexit and its implications. Here are my answers to the questions posed by the FT:

1) To what extent will Brexit-related uncertainty in the first quarter of the year affect the UK economy?

The outlook for the economy depends upon the interactions between the fundamentals, policy and confidence. Brexit uncertainty will impact via policy and confidence. The economy could easily come to a standstill in the early months, as political uncertainty overshadows all else. As raw politics may dominate in early 2019, one has to keep options open regarding Brexit and economic policy.

The most likely Brexit scenarios appear to be either:

• An acceptance of the Prime Minister’s Withdrawal Agreement, most probably with a change to the backstop for Parliament to accept it. Indeed, as the possibility of no-deal becomes more likely, then there may be an increased likelihood of the EU offering an enhanced offer to the UK. Here there would be a transition agreement, which while not removing uncertainty, would ease the pace of adjustment; or:
• A managed no-deal or exit on WTO terms, which would likely involve agreement during the first quarter on sector specific deals. While uncertainty would likely persist until the end of March, this might be alleviated sooner if it was clear the UK and EU were preparing after March to reach a free trade agreement, as I think they would.

In the event of a managed no-deal, one should expect plans to be in place for monetary and fiscal stimulus in the second quarter. While increased preparation in the first quarter for a managed no-deal may trigger some increased business spending, it is hard to fully quantify this likely impact and it is likely to be offset by a delay in other spending plans.

Likewise, it is hard to forecast the impact of any uncertainty, particularly as that should keep sterling competitive and encourage the Bank to have a bias towards easier policy – although in all likelihood they will likely keep policy on hold in the first quarter.

It is not just Brexit uncertainty, but the currently negative mood overhanging global financial markets may weigh on spending and investment plans, leading to a deferment of these.

2) How will Brexit affect the UK economy over the course of 2019?

This depends upon the agreement made and the path subsequently chosen. If there is an agreement, and thus certainty about what lies ahead, then there could be a deal dividend, as the Chancellor has indicated. If there is a managed no-deal then how this impacts the economy will depend, crucially, on planning and on any agreements made in the first few months of the year, as indicated in the previous answer.

Its impact will be greatest on those sectors currently enjoying frictionless trade with the EU but that could be minimised or indeed offset by expectation of a future free trade agreement. My forecast is for the economy to grow 1.5% in 2019 and 2.2% in 2020, helped by greater certainty about what lies ahead

3) Real wages are finally rising, but will households feel better off at the end of 2019?

They probably will feel much as they do now, although at least the uncertainty over Brexit should have been lifted. I expect inflation to remain low, and thus there should be real wage growth, which should underpin confidence.

Although the solid UK labour market and rising wage growth could underpin consumption, household spending may be soft in the early months of the year, with a near-term rise in savings. House prices may stagnate during 2019, and thus have a neutral impact on confidence, as they will still be expensive for those looking to buy.

4) How far will the government act in 2019 on its promise to end austerity?

The government has already indicated its broad plans in this area. The Chancellor has already outlined the path of spending until 2023-24 and the details of that will be unveiled in the Comprehensive Spending Review. While the headline figure suggests an end to austerity, the breakdown, as we already know, suggests that there will be little scope to boost spending in the previously non-ringfenced areas. Thus, the pressure will remain on these.

In recent years, the combination of steady growth in nominal GDP and continued low rates and yields has allowed favourable debt dynamics to reduce the budget deficit. This trend could continue, and if so, should allow the government more room for fiscal manoeuvre.

5) How will monetary policy change in 2019? Do you think the Bank of England will get it right?

I don’t expect monetary policy to change in the early months of the year. There has already been significant monetary policy tightening over the last year. The combination of a small tweak in rates, ending of lending schemes, hike in counter-cyclical capital buffers, plus, perhaps, more general tightening of lending as a result of micro-prudential measures, has led to sluggish lending and monetary growth. While rates are low and sterling is competitive, financial conditions are far from loose.

Will the Bank get it right? Naturally, I hope so. While there is some excellent analysis that comes out of the Bank their forward guidance on the economy has left much to be desired. My view is that there should be a bias towards easing early in the year, aimed at stimulating lending and monetary growth, but as the year progresses there may be scope to change the bias towards tightening. To get it right, the Bank needs to be gradual and predictable in its actions.

6) Is there anything else you would like to tell us?

Despite near-term political uncertainty, I remain positive that Brexit will bring longer-term benefits to the economy. To make a success of Brexit the UK needs to get three areas right: our future relationship with the EU; positioning ourselves globally; and our domestic economic and financial agenda.

There would be a major constraint on future economic success if our relationship with the EU places constraints upon our global ambitions or our domestic policy, where we need to address the imbalances in the economy and boost investment and infrastructure spending, encourage innovation and have the right policy incentives in place.

Please remember that when investing your capital is at risk.