Outrageous fortune?

15 Mar 2017

Richard Jeffrey

Richard Jeffrey

Chief Economist

It is ironic, perhaps, that just as the authorities are in the midst aggrandising their growth numbers for 2017, the economy seems to be losing a bit of momentum. In its latest forecasts, published in the February Inflation Report, the Bank of England suggested that the economy will grow by 2.1% this year if interest rates are left unchanged. And it seems that the Office for Budget Responsibility (OBR) is about to push its growth estimate in the same direction. The previous forecasts from both the Bank and OBR, both produced in November last year, homed in on the same growth number for 2017 – 1.4%.

I will not rekindle the debate as to why forecasts were reduced so dramatically in the first place. I am sure in years to come, economic historians will be quite damning of the forecasts made by institutions and factions on both sides of the Brexit debate; nonetheless, it is evident that the referendum result did not have the immediately depressing impact on economic activity that was widely predicted.

The area that has been most immediately and obviously impacted by the UK’s exit vote has been the currency, which, depending on how you measure it, has lost around 15% of its pre-referendum value. Sterling is a notoriously volatile currency. While the past nine months have been a period of considerable weakness, this is far from being unprecedented. Between mid-2007 and late-2008 for instance, it depreciated by around 25%, to a similar level as that prevailing today. On the other hand, between mid-2013 and mid-2015, it appreciated by 15%. And during my career as a professional economist, I can remember the pound trading as high as 2.45 against the US dollar and as low as 1.05 – from where it subsequently appreciated by more than 40% over a period of about nine months.

While periods of severe currency volatility are not uncommon, they can be damaging; however, the history of the pound since the start of the 1980s suggests that greater damage is done to the reputations of central bankers and economists than to underlying economic activity.

With regard to the performance of the economy in 2017, we are trying to gauge the extent of two different influences of sterling’s recent battering. First, higher import prices generally, combined more specifically with rising energy costs, are feeding through to high-street pricing. Against the backdrop of only slow growth in average earnings, this implies that real growth in household spending could be squeezed. However, the system has many moving parts. It is likely that wages will increase faster in 2017 than during the recent few years, in addition to which, a lower savings ratio may absorb some of the shock of reduced real income growth. At the moment, it seems as though household spending has decelerated, but it would be foolish to extrapolate from a pre- and post-end-year spending period that is notoriously difficult to interpret.

Having said that, all other things being equal, you might think that higher inflation would be detrimental to consumption. True… but if inflation is expected to be even higher in the following period, then it is possible that households will bring forward future planned spending, even if current real incomes are being squeezed.

The second significant sterling effect will be on trade flows. A currency depreciation improves UK producers’ competitiveness in both export and import markets. Again, this impact is not as clean as it initially might appear. Improved competitiveness takes time to feed through to real orders and sales, and in between times, the trade balance will almost certainly show the detrimental impact of the rising cost of imports. Also, improved competitiveness resulting from a currency move can be partially offset by the rising cost of raw materials and energy used in the production process. Furthermore, some companies competing with overseas producers may choose to take some of the benefit of improved competitiveness through raising prices and markings rather than volumes. This might show through in higher export values, but it will restrict the impact on real GDP.

Economists are not good at anticipating turning points or even inflection points in the economic cycle. The history of forecasting reveals an alarming tendency towards taking the two most recent data points and extending into the future, with the aid of the indispensable 15 inch ruler. We have all fallen into this trap, one that the authorities, with their huge teams of economic analysts, have proven no better at avoiding.

For 2017, there are many unknowns working in varying directions and at differing speeds. In the past, I have tended to place a lot of faith in the intrinsic resilience of the economy. On this occasion, it would seem that even if the central growth forecast for 2017 is moving towards 2%, there are greater risks to the downside than the up. Even so, one of the aspects of the economy that could yet provide a positive surprise is capital investment. It has been universally assumed that capital spending would show persistent weakness in the period between the referendum and the actual moment of Brexit – reflecting the negative impact of uncertainty. However, I think there is a likelihood that investment will be boosted by companies preparing to develop new markets outside the EU area. How quickly and with what strength this comes through remains to be seen. However, it may well be that even in 2017, companies undertake higher levels of productivity-enhancing investment spending than is generally expected.


Richard Jeffrey

Richard Jeffrey

Chief Economist

Richard Jeffrey was Chief Economist at Cazenove Capital until he retired in January 2018. 


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