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Policy not Panic – For Britain’s economy in 2016, the biggest question will be vision

Much depends upon the interaction between the economic fundamentals, policy and confidence, including developments overseas and in the financial markets. Events over the last week are unlikely to have helped business or consumer confidence as stock markets across the globe have tumbled.

The Markets – No need for panic. Let’s take the markets first. In recent years global financial markets have been helped by a combination of factors: first, low interest rates and accommodative monetary policies in the West; second, despite problems in the US and Europe, the world economy remained relatively robust, helped by China; third, clarity about policy in the major economies and an absence of policy shocks. Then since last August that changed. Events over the last week are a continuation of this. These three stabilising factors have all started to unwind. First, the Fed hiked in December and there are misplaced fears of further to come. Second, China is having a hard landing, with growth weaker than the 7 per cent suggested by official figures, so world growth is sluggish. Third, clarity about policy has been replaced by policy uncertainty, with a lack of clarity in America, unease in OPEC and China threatening to devalue again.

My message is not to panic. Volatility in markets is not new, and while China is slowing, it’s longer term outlook is still positive. Moreover, the UK economy will be helped by low oil prices and continued low interest rates. I think the UK will grow at a modest pace this year, around 2.5 per cent, with inflation low, around 0.5 per cent. News this week that car sales hit an all time high in 2015, suggests that some people have the need, confidence and ability to spend, even on high ticket items. Likewise, too, with home purchases, although the level of house prices is a concern. Yet, as good as the recovery is, it is still relatively modest for this stage of the economic cycle.

Unstable Recovery. Furthermore, despite a number of years of growth, the recovery appears as imbalanced as ever. While the Chancellor focuses on reducing the budget deficit, and the currency markets keep a close eye on the current account deficit, personal debt is also a concern. Wages are only rising slowly so personal borrowing stays high. As the year progresses, consumer spending should strengthen, helped by rising real incomes, although this will contribute to rising house prices and rents, acting as a squeeze for others. The message is the fundamentals at home point to recovery, butsuch recovery is vulnerable to policy mistakes or a hit to confidence.

Policy Matters: When it comes to policy it appears to be more of the same. Fiscal policy is tight, but not as much as it might have been, following the Autumn Statement. However there is still uncertainty over the ability to cut spending in the non-ring fenced areas and whether tax receipts will hit targets. Growth is the key. As a result, monetary policy will remain the shock absorber for the economy. I don’t expect interest rates to rise this year. Even when they do eventually rise, they will still have to stay low for some time. The combination of a relatively tight fiscal policy, low inflation and the balance of risks suggests the Bank of England needs more evidence of strong consumer spending. For most people wages are still low. Graduates worry about jobs, although jobs are at an all time high. High earners worry about house prices, if not for them then for their children. The economy has not yet reached escape velocity.

Although house prices – and let’s not overlook rents – are too high, the answer is not higher interest rates. We may need to see further progress in the Bank of England’s use of macro and micro prudential measures to curb property prices. This is still a vague area, but it has included tougher lending constraints in recent years. Of course what is needed is massive house building, but this is still some way off, not helped by skill shortages and an apparent reluctance of developers to build on the scale required. Little wonder the government is stepping in.

The Referendum What about the Referendum? The last time I have known an economic consensus so convinced of anything was before ‘Black Wednesday’, when we were told exit from the ERM would lead to recession, inflation and higher rates. In fact Black Wednesday triggered recovery as sterling and interest rates fell and confidence recovered. I didn’t agree with the consensus then and, likewise, I think the consensus is far too pessimistic about Brexit now. Brexit is better than staying in an unreformed EU. The Prime Minister will need change – and says as much himself – if Britain is not to vote leave. None the less, sterling may be vulnerable, not helped by the uncertainty ahead of the Referendum and by the UK’s large trade deficit.

What about confidence? This is always the hardest to call. Even if people are seeing their own situation improve they may still become cautious if they believe things will get worse. Volatility in financial markets or fears of higher rates don’t help. There are considerable uncertainties out there, but there have been for some time, certainly since the 2007-08 financial crisis, and as some of us were then warning, before it too.

The Global Picture & a Vision for Britain. It is important that people are given some context about the global picture and about the vision that lies ahead for the UK. While a reality check is necessary, a more upbeat message is needed too. This need not be unnecessary optimism about now, but the lack of a vision is, in my opinion, one of the bigger challenges facing the UK, in or out of the EU. So it is not plain sailing, but perhaps, as with China, for the UK we should be concerned but should not panic.

 

Dr Gerard Lyons

Dr Gerard Lyons is an international economist and Chief Economic Strategist at Netwealth Investments, having previously served as Chief Economic Adviser to Boris Johnson while he was Mayor of London. He was Co-Founder of Economists for Brexit and is co-author with Liam Halligan of Clean Brexit (Biteback, 2017). For Politeia he was co-author of Banking on Recovery: Towards an accountable, stable financial sector (2016).

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