Future-gazing in these impossible times

Summary of David Smith’s talk at CIL’s breakfast seminar – 18 September 2018

 

A decade after the global financial crash, many economists claim to have seen the crunch coming, though Smith did not remember them doing so at the time. No doubt in ten years, time everybody will say they saw it coming. So said David Smith, Economics Editor of the Sunday Times, as he began his lecture at CIL Management Consultants’ annual breakfast briefing.

 

The shocks and surprises keep coming, he pointed out. A financial crisis that nearly paralysed the global banking system has been followed by ten years of near-zero interest rates, a European crisis in which Greece came close to collapsing the eurozone, the UK’s vote to leave the European Union, Donald Trump’s election to the US Presidency and the evolution of a political environment in the UK in which both main parties are mired in potentially existential division.

 

Remarkably, given that backdrop, the global economy is showing resilience. Mr Smith pointed to an upbeat assessment from the International Monetary Fund (IMF), which is currently predicting 3.9% global economic growth for both 2018 and 2019. That’s back to long-term trend performance. Meanwhile, monetary policy in some regions finally appears to be normalising, with the US in particular raising interest rates and beginning to reverse its quantitative easing programme.

 

However, Mr Smith warned that these more positive times may not last. While the corporate tax cuts unveiled by the Trump administration have boosted the US economy – and by extension the rest of the world – the President’s protectionist instincts pose a threat to further growth, with more trade tariffs unveiled in recent days.

 

Moreover, global economic performance now looks patchy. While the US continues to drive growth, the IMF is now downgrading its forecasts for the economies of the eurozone, Japan and the UK. Emerging markets are also a cause for concern, Mr Smith cautioned. Countries such as Turkey and Argentina, with large borrowings in the dollar-denominated international debt markets, are being hit very hard by the strength of the US currency, though he does not expect a full-blown emerging markets crisis.

 

UK economy struggling to break out of anaemic growth

 

So where does that leave the UK?

 

The UK has been boosted by stronger global growth, but 2018 has been disappointing, Mr Smith said, with the economy now growing at around 1.5% a year, roughly half the rate of three years ago. Consumer-facing sectors such as retail and leisure are particularly weak, while manufacturing has slowed following a purple patch; construction, too, is very mixed.

 

With the UK’s interest rates still so low and Brexit having caused such uncertainty, the value of the pound has fallen consistently. Mr Smith estimated that sterling appears to have settled around 10% below its pre-EU referendum levels; a well-regarded Brexit deal might provide a fillip, but no-deal would cause further declines Mr Smith said.

 

One important effect of sterling’s weakness has been to push inflation higher, to around 2.5% today compared to zero three years ago. Meanwhile, wage inflation has remained static – while earnings have risen by around 0.2% in real terms this year, they remain 6% below pre-financial crisis levels. The squeeze on household incomes has been a major factor in the travails of high-street retailers and casual dining chains, Mr Smith explained.

 

More positively, the employment market is remarkably strong, with joblessness at its lowest level since 1974 and employment at close to an all-time high. The sheer number of people in work and earning an income has provided some support to the economy Mr Smith said, though the UK’s productivity problem – the country is roughly 20% below where it might have been expected to be before the financial crisis – undermines the effect.

 

On the public finances, Mr Smith pointed out that the UK’s budget deficit is now down to around 2%, more or less on target to hit the Government’s target of not borrowing other than to invest. But Mr Smith said his discussions with the Treasury suggested there was little complacency, with officials and ministers concerned about the outlook and determined to pursue further fiscal conservatism. With taxes politically difficult to increase, that means further pressure on spending, he predicted.

 

Against this background, businesses are likely to remain cautious, Mr Smith said, particularly until they have a clearer view of the post-Brexit landscape. While the Bank of England has suggested a Brexit deal might provide a boost, encouraging businesses to begin investing more, Mr Smith said he thought this was unlikely given that any deal is likely to be high-level rather than detailed.

 

Similarly, the drivers for consumer spending look weak. Poor real wages growth, the cooling housing market, nervousness about over-borrowing and some evidence that the employment market is now beginning to slow all represent headwinds.

 

Overall, the outlook is concerning, Mr Smith said. While the UK once expected economic growth to come in at 2.5% to 3% a year, it now seems to be stuck at around 1.5% – the sort of levels once associated with sclerotic European economies we expected to outperform. Breaking out of this cycle will be difficult, he warned.

 

Where now for interest rates?

 

Mr Smith joked that covering interest rates had been exciting over the past year, with two increases in the Bank of England’s base rate in eight months (to 0.75% today) after none for more than a decade. Still, interest rates remain exceptionally low – Mr Smith pointed out that before 2008, the base rate had never gone lower than 2%.

 

The Bank’s Monetary Policy Committee has moved back towards raising rates partly to address rising inflation – particularly since even the current anaemic level of growth does seem to be pushing the economy towards capacity – but also because it wants to begin returning to more normal times.

 

Nevertheless, Mr Smith said he thought the “new normal” was more likely to be rates of around 2 per cent and he predicted there would be no further increases until summer 2019. Even then, further increases would be small and gradual, he said.

 

Brexit remains the big unknown

 

Finally, Mr Smith turned his attentions to Brexit. He said he believed the chances of the UK agreeing a deal on the terms of its withdrawal from the EU were roughly two to one in favour. He thought that deal was most likely to be broadly in line with the Prime Minister’s Chequers proposal – effectively a single market for goods – though other options, including EEA membership, are still possible.

 

Mr Smith also said a second referendum was unlikely, though he predicted the Labour Party would move towards supporting a vote on a deal with the EU. Public opinion on Brexit appeared relatively consistent, he pointed out, with those thinking the leave vote was a mistake roughly 5% ahead; this isn’t enough to persuade politicians to be bolder, he said.

 

The prospect of no deal is a real worry, Mr Smith added. He said Government officials had worked hard to get that message out over the summer, to counter suggestions from hard Brexiteers that no deal might not be so bad – officials fear a sharp contraction in the economy, major problems with the EU supply chain, a political crisis and even social unrest.

 

Mr Smith also reminded the audience that agreeing a deal on withdrawal was just a starting point for the UK. Much more work would then be required to agree terms of trade – both with the EU and other countries around the world. The uncertainty will continue for some time.

 

Still, there will be winners and losers, he added. The services sector, for example, may benefit from deregulation outside of the EU.

 

Final thoughts: reasons to be nervous

 

Mr Smith concluded with two observations. First, he argued, the prospect of a Labour Government under Jeremy Corbyn should worry people: a government with an anti-capitalist, anti-business agenda – and plans for higher taxes – would add to the post-Brexit difficulties the UK faces.

 

Second, he reported back on his own “Skip Index”. In previous years, Mr Smith has assessed the UK’s economic strength according to the number of skips on his street – from zero, meaning recession, to four or more suggesting an unsustainable boom. Right now, he explained, just one of his neighbours has a skip on their drive. These are cautious times.