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The big news today is that the economy is doing significantly better post the EU Referendum than the Bank of England has initially envisaged.
Expect the pound to strengthen today off the back of this announcement.
The Bank’s GDP estimate for 2017 is now 2%.
Back in November, it estimated that it would would only be 1.4% this year – and as far back as August, it forecast that GDP would be just 0.8% this year.
So what accounts for this big change in the Bank of England’s forecast? Why do they think the UK economy is going to do better than expected this year?
It’s to do with a number of factors.
In part, it is to do with how well it expects the global economy as a whole to do this year; in part because unemployment has not increased as they thought it would.
But largely, it’s to do with the resilience of the British consumer who has not only kept calm and carried on spending, but actually been spending more. The Bank notes “robust growth in consumer spending”.
Remember retail sales rose by 1.3% from August to November. This is partly because people have been drawing on savings significantly (the savings rate is down to a record low), and in part because credit card debt has gone up.
Of course, both of these behaviours, if they persist, could prove problematic later down the line.
When it comes to next year and the year after, the Bank’s forecasts from November remain broadly speaking unchanged, although slightly better than expected.
Next year they expect the economy to slow down – a GDP of 1.6%. In 2019 they expect it to be 1.7%.
A large part of the reason the Bank expects growth still to slow down next year and the year after is because the Bank does still expect consumer spending to drop – it just now predicts it will happen later than initially expected.
The key reason it will slow down? Inflation.
The Bank expects inflation to rise this year at a higher rate than it had initially thought – 2% this year, and then 2.7% in 2018.
And because it expects wages to basically remain flat, households will soon feel the squeeze.
Basically, the drop in sterling since the referendum will lead to this surge in inflation. While the pound has strengthened in past few weeks, it’s still 18% below its late 2015 peak.
Forecasting in what I have called ‘The Age of Radical Uncertainty’ is, of course, incredibly hard.
So it’s worthwhile thinking about some of the key game changers that could up end the Bank’s forecast:
- Brexit: At the moment the Bank is using an average of potential post-Brexit trading relationships in its forecasting. Once it adjusts this to the reality this will of course have a significant impact on its forecasts.
- The US: At the moment the market (and the Bank) is assuming that Trump Presidency will boost the US economy this year because of its planned fiscal stimulus. But is the “Trump Risk” being adequately priced in?
- China: Should the Chinese domestic debt situation require government intervention that could impede growth.
- Russia: An emboldened Russia now that Trump is president inevitably increases geopolitical risk.