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COMMUNITY UPDATE

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In January, The World Bank raised its forecast on UK growth from 1.2 to 1.7 percent. Despite it being lower than last year’s growth of 1.8 percent, it reflects increasing confidence in the country’s economic resilience. So, has the impact of Brexit been over-estimated, or are we yet to hit the iceberg? 

“Most forecasters upgraded their predictions for the UK this year because the early fallout from Brexit was not as significant as expected; that’s because companies chose to wait until after 2016 to react. There are many possible outcomes, so it makes sense to hold off from making significant investment changes,” says Dominic Swords, Visiting Professor of Business Economics, Henley Business School.

The question, particularly for the Bank of England’s Monetary Policy Committee, is how long our economy can accommodate this ‘on hold’ period.

“As months go by the consensus strengthens for an interest rate rise to head off inflation. The dilemma is that interest rates will hit domestic activity while the main contribution to inflation is actually created through import prices and the recent fall in sterling,” he explains.

The pressure to raise interest rates has subsided for now as inflation unexpectedly fell from 2.9 per cent in May to 2.6 per cent in June. This is the first drop since October 2016, and is thought to be largely due to lower oil prices. 

At this stage there is simply no telling where Brexit may take us in the longer term. Dominic believes that beyond a two-year horizon there is such a dispersion of possibilities that meaningful planning becomes very hard.

Marcus Wright, Senior Economist at the Royal Bank of Scotland, recommends building business projections for the coming two years around three possible outcomes; a consensus-aligned view, a more positive version of it and a downside scenario. 

“On the upside is a soft Brexit under which we remain part of the single market, something akin to the relationship Norway has with the EU. This scenario envisages GDP growth of about 2 per cent per year,” says Marcus.

“The worst scenario has us hitting much lower growth by 2019, coupled with a rise in unemployment and an aggressive response from the Bank of England. That prediction imagines us falling off the so-called ‘cliff’ and into WTO rules, with the potential for numerous tariff and non-tariff barriers. That would likely make business very hard for many companies,” he adds.  

“The middle, and most likely outcome, is that we leave the single market with a transitional period of at least two years, possibly more. This would give more time to establish the nature of the economic and trading relationship with the EU. It wouldn’t mean plain sailing for the economy but it should muddle along with growth of 1 to 1.5 per cent over the coming few years.” 
 
 
Economic Barometers 
 
These three scenarios paint just some of the many landscapes that may materialise. Indeed, the possibilities are so varied, they may leave you feeling immobilised. According to Andrew Minton, Managing Director at Criticaleye, business leaders must ensure they don’t let that happen. 

“Leaders will be used to keeping watch on the economy but have to increase their scrutiny in today’s environment of uncertainty and volatility,” he says.

“It’s not enough to be passive about how you assess the world around you or kid yourself into thinking you don’t need a plan. Greater uncertainty calls for more questions, better risk analysis and more in-depth scenario planning.”

Consumer spending and employment are two important barometers to watch while we wait for the future to unfold. They show in real time the effects of economic activity. 

“I think consumers believe things will be okay. There has been robust consumer spending, even on big ticket items such as cars. However, I see that changing over the next 12 months with the effect of sterling on domestic inflation reducing consumer spending. I think people are yet to realise that there are some quite significant risks ahead of us,” says Dominic.

However, Marcus is already seeing signs of weakness. “The rate of inflation is above the rate of wage growth, putting a squeeze on consumer spending. Wage growth in nominal terms has been slowing since the autumn and it wasn’t particularly high to begin with,” he says.

Considering the recent drop in inflation we may see some changes to spending, yet there is no guarantee that uptick will hold, especially as the impact of the fall in sterling is still filtering into consumer prices. According to Marcus, inflation is expected to remain close to its current level throughout the remainder of this year, before gradually moderating over the course of 2018.
 
 
The Social Factors 

Of course the greatest influence on consumer spending is employment rates. While they are still in line with the pre-crisis boom, social factors – chiefly technology – are set to have a significant impact. 

Devyani Vaishampayan, founder of HR Technology Partnership has been a global HRD for many years. She sees this factor at play across borders. “In India this year there is estimated to be more than 100,000 software professionals laid off because the skills requirement has shifted to a higher level and many roles are now automated,” she says.

“Here in the UK, many start-ups are using AI in a way that is rapidly disrupting the workplace. Five years from now, over one-third of skills that are considered important in today’s workforce will have changed. By 2020, robotics and machine learning will dominate many fields.”

The long-term concern is that technology will result in so many job losses that consumer spending will significantly decline. Moreover, there will be a sharper divide between the classes, which could shake the foundations of the West’s politics and economy. 

Rik De Vos, CEO of McBride, a British-based manufacturer of household and personal care goods, notes: “Social divergence is widening, especially in more developed and democratic economies. Unfortunately, in those countries, the mechanism for people to express frustration is through elections and this is creating huge political unrest. As we have seen, Brexit and recent elections have led to further political − and therefore economic – instability.” 

Dominic can also see this worrying pattern take shape. He says: “I do foresee more instability in democratic societies and the unfortunate situation is that it means we’re creating so much domestic disruption we’re taking our eyes off the ball in terms of maintaining our position in the context of global growth.”
 
 
By Mary-Anne Baldwin, Corporate Editor, Criticaleye
 
These comments were shared during Criticaleye’s recent Global Conference Call, Spotlight on the Global Economy
 
Want to learn more on the UK economy? Read the EY ITEM Club Summer Forecast 2017 or EY ITEM Club Special Report on Consumer Spending