Economic Prospects: Getting to Grips with 2018
Today the Financial Times provides the results of its annual survey of UK economists. The main message is that economists are cautious about prospects in the year ahead, largely because of the uncertainty associated with Brexit. About half expect economic growth of between 1% to 1.5%. This compares with likely growth of 1.7% in 2017. Our forecast, outlined below, is slightly more upbeat than this. Also, the bulk of economists expect the Bank of England to gradually tighten policy in 2018. About 18% of respondents expect no change in interest rates, about 27% forecast a quarter point rise, and around one-third see a half point increase during 2018. Our forecast is in line with this latter group, for a total interest rate rise of 0.5% this year.
All the individual replies from the economists to the six questions can be read online on the FT’s website. Here are our responses to the FT’s questions.
Growth: how fast do you think the UK economy will grow in 2018?
I expect the UK economy to grow just under 2 per cent, with a faster pace of growth than in 2017. The fundamentals are improving, the impact of policy on growth may be broadly neutral in 2018, but it is confidence that is the big unknown. If consumer and business confidence recover during 2018 then that might give a boost to growth. I expect inflation to decelerate and wage growth to accelerate, underpinning consumer spending at a modest pace. Exports should benefit from sterling’s competitiveness and the recovery in world trade. Even if firms put their investment plans on hold, because of Brexit, at some stage they will need to invest, but perhaps that boost will come in future years.
The positive surprise in 2018 - both in the UK and elsewhere - could be a faster improvement in budget finances as nominal GDP grows steadily and borrowing yields remain relatively low.
I was optimistic about the world economy in 2017 and remain upbeat about global growth prospects for the year ahead. Although I still feel we are in a disinflationary environment, and UK inflation will decelerate, a potential risk is higher global inflationary pressures, especially if oil prices firm.
Brexit: compared to what you thought 12 months ago about the UK's long-term economic prospects outside the EU, are you now more optimistic or more pessimistic than you were?
I have not changed my view on Brexit over the last year. Some things could have been handled differently but we are where we are, and this is the basis on which we need to look ahead. I remain strongly of the view that Brexit is in the best long-term interests of the country. While there are challenges with leaving the EU, Brexit provides significant opportunities that we need to seize. But, before the referendum result and since, I described leaving as an economic shock and that the impact on economic growth would be like a ‘Nike swoosh’, with growth slowing, as it has, because of political and policy uncertainty, before recovering solidly.
Despite the cyclical recovery underway in Europe, which I expected, we should be relieved we are distancing ourselves from a euro area that is fundamentally flawed and an EU that has made clear its ambitions to become a political union.
The legacy of the 2008 financial crisis has not been addressed. The UK has an imbalanced economy. Some parts are world class and global leaders, others are in deep need of repair. Now we have an opportunity to address fully our domestic and regional agenda, with Westminster able to set the laws and policies to suit best our domestic needs. The UK, like the EU, needs to reposition itself in a changing and growing global economy. There needs to be a sea-change in economic thinking in the UK to address some deep rooted problems in our domestic economy. That was never going to occur within the EU. Returning competencies from Brussels, having a sensible immigration policy, setting the right tax, spending and regulation policies and focusing on innovation, investment and infrastructure will all be part of this.
The UK needs to focus on three areas: its future relationship with the EU; its opportunities with the rest of the world; and addressing its domestic economic agenda. In 2018 the focus will be on the future relationship with the EU. I expect the UK will agree a deal with the EU and if the government holds its nerve this will include a favourable deal for the City based on equivalence, and will be of mutual benefit to the UK and the EU.
Consumers: will 2018 be an easier year for UK households and what are the implications for consumer spending?
I expect 2018 to be a better year for UK households. This will be driven by a combination of factors, including a boost to household incomes and a deceleration in inflation. In the next answer I explain why I think wage growth will accelerate. The net result should be a rise in real incomes. Consumption may also receive a boost from a fall in the savings ratio, but if so this may be small. Household debt is rising gradually, as too are household assets. Vitally important will be confidence, and this will be impacted by many factors, including a solid labour market, the sensitivity of personal finances to higher rates and also by a clear, positive vision being outlined for the economy.
Wages: how much of a pay rise will British workers get in 2018?
Wage growth should pick up in 2018, and this could yet prove to be significant. The longer-term structural factors that have held back wage growth remain in place, such as global competition, technology, financialisation and the demise of unions, although the latter may be changing in some sectors. There are still issues to be concerned about, including zero hour contracts. While at City Hall, I championed the London Living Wage and while I would like to see higher wage growth, I then became acutely aware of the pressure placed on small firms from policy measures - and in 2018 the impact of auto-enrolment and the apprenticeship level could limit some firms' ability to pay higher wages. Thus, the government needs to keep taxes and regulations low, for small and medium sized firms. There are many different factors at play in the wage outlook. Supporting the view of higher wage growth includes a recent report from the Bank of England agents that earnings growth looks set to accelerate, the more favourable environment for self-employment and the tightness of the labour market.
Rates: how far will the Bank of England raise interest rates next year?
I expect the Bank of England to raise rates twice in 2018, mid and year-end. Naturally, the Monetary Policy Committee (MPC) and the Financial Policy Committee (FPC) need to coordinate closely.
Also, I think this is what the Bank should be planning, as they rebalance policy. But they but do need to err on the side of gradualism, particularly if inflation decelerates, as I think it will, and as consumer and business uncertainty could be vulnerable to continued uncertainty regarding the EU exit and the constant and unnecessary talking down of our future economic prospects.
In the wake of the global financial crisis, global monetary policy was best defined by the three S’s, being synchronised, sizeable and successful. Now, for the UK, we need to focus on these three S’s: sequence, scale and sensitivity. This means getting the sequence right between hikes and withdrawing QE, a gradual scale of tightening and that policy makers need to be aware of how sensitive the economy and markets could be to this policy. This points to a gradual and predictable exit strategy that avoids policy shocks.
Productivity: will the UK experience a resurgence of productivity growth in 2018?
Productivity growth has the potential to recover, and I think it will. But I would not use the word resurgence, as your question does, as there is no magical solution to low UK productivity, but marginal improvements can make a difference. The UK has a productivity gap across regions, within regions, and within sectors too. Moreover, diffusion of productivity gains is low. That is, the benefits enjoyed by high productive firms or areas are not always shared more widely.
In my view, we can make progress by focusing on the four "I's" of incentives, investment, inclusivity and infrastructure. For instance, incentives matter, particularly to attract big firms to clusters, where similar firms in a sector can be based. Boosting local competitive advantage is key to building the clusters of economic power that help drive productivity growth. Also, the UK has invested too little in physical and human capital, including skills and on the job training. Inclusive productivity growth matters, to spread the gains. The UK has a large number of low-productive sectors, five of which account for one-third of UK output and close to half of jobs. Also, 'inclusive' relates to addressing the large regional variation, including the huge gap in productivity between London and other cities. We need to spend more, and sensibly, on infrastructure, led by the government and ideally by attracting long-term private sector savings. We are now making some good advances on infrastructure, but there is a long way to go.
You can read the full annual survey on the Financial Times’ website by clicking here.
All the individual replies from the economists to the six questions can be read online on the FT’s website. Here are our responses to the FT’s questions.
Growth: how fast do you think the UK economy will grow in 2018?
I expect the UK economy to grow just under 2 per cent, with a faster pace of growth than in 2017. The fundamentals are improving, the impact of policy on growth may be broadly neutral in 2018, but it is confidence that is the big unknown. If consumer and business confidence recover during 2018 then that might give a boost to growth. I expect inflation to decelerate and wage growth to accelerate, underpinning consumer spending at a modest pace. Exports should benefit from sterling’s competitiveness and the recovery in world trade. Even if firms put their investment plans on hold, because of Brexit, at some stage they will need to invest, but perhaps that boost will come in future years.
The positive surprise in 2018 - both in the UK and elsewhere - could be a faster improvement in budget finances as nominal GDP grows steadily and borrowing yields remain relatively low.
I was optimistic about the world economy in 2017 and remain upbeat about global growth prospects for the year ahead. Although I still feel we are in a disinflationary environment, and UK inflation will decelerate, a potential risk is higher global inflationary pressures, especially if oil prices firm.
Brexit: compared to what you thought 12 months ago about the UK's long-term economic prospects outside the EU, are you now more optimistic or more pessimistic than you were?
I have not changed my view on Brexit over the last year. Some things could have been handled differently but we are where we are, and this is the basis on which we need to look ahead. I remain strongly of the view that Brexit is in the best long-term interests of the country. While there are challenges with leaving the EU, Brexit provides significant opportunities that we need to seize. But, before the referendum result and since, I described leaving as an economic shock and that the impact on economic growth would be like a ‘Nike swoosh’, with growth slowing, as it has, because of political and policy uncertainty, before recovering solidly.
Despite the cyclical recovery underway in Europe, which I expected, we should be relieved we are distancing ourselves from a euro area that is fundamentally flawed and an EU that has made clear its ambitions to become a political union.
The legacy of the 2008 financial crisis has not been addressed. The UK has an imbalanced economy. Some parts are world class and global leaders, others are in deep need of repair. Now we have an opportunity to address fully our domestic and regional agenda, with Westminster able to set the laws and policies to suit best our domestic needs. The UK, like the EU, needs to reposition itself in a changing and growing global economy. There needs to be a sea-change in economic thinking in the UK to address some deep rooted problems in our domestic economy. That was never going to occur within the EU. Returning competencies from Brussels, having a sensible immigration policy, setting the right tax, spending and regulation policies and focusing on innovation, investment and infrastructure will all be part of this.
The UK needs to focus on three areas: its future relationship with the EU; its opportunities with the rest of the world; and addressing its domestic economic agenda. In 2018 the focus will be on the future relationship with the EU. I expect the UK will agree a deal with the EU and if the government holds its nerve this will include a favourable deal for the City based on equivalence, and will be of mutual benefit to the UK and the EU.
Consumers: will 2018 be an easier year for UK households and what are the implications for consumer spending?
I expect 2018 to be a better year for UK households. This will be driven by a combination of factors, including a boost to household incomes and a deceleration in inflation. In the next answer I explain why I think wage growth will accelerate. The net result should be a rise in real incomes. Consumption may also receive a boost from a fall in the savings ratio, but if so this may be small. Household debt is rising gradually, as too are household assets. Vitally important will be confidence, and this will be impacted by many factors, including a solid labour market, the sensitivity of personal finances to higher rates and also by a clear, positive vision being outlined for the economy.
Wages: how much of a pay rise will British workers get in 2018?
Wage growth should pick up in 2018, and this could yet prove to be significant. The longer-term structural factors that have held back wage growth remain in place, such as global competition, technology, financialisation and the demise of unions, although the latter may be changing in some sectors. There are still issues to be concerned about, including zero hour contracts. While at City Hall, I championed the London Living Wage and while I would like to see higher wage growth, I then became acutely aware of the pressure placed on small firms from policy measures - and in 2018 the impact of auto-enrolment and the apprenticeship level could limit some firms' ability to pay higher wages. Thus, the government needs to keep taxes and regulations low, for small and medium sized firms. There are many different factors at play in the wage outlook. Supporting the view of higher wage growth includes a recent report from the Bank of England agents that earnings growth looks set to accelerate, the more favourable environment for self-employment and the tightness of the labour market.
Rates: how far will the Bank of England raise interest rates next year?
I expect the Bank of England to raise rates twice in 2018, mid and year-end. Naturally, the Monetary Policy Committee (MPC) and the Financial Policy Committee (FPC) need to coordinate closely.
Also, I think this is what the Bank should be planning, as they rebalance policy. But they but do need to err on the side of gradualism, particularly if inflation decelerates, as I think it will, and as consumer and business uncertainty could be vulnerable to continued uncertainty regarding the EU exit and the constant and unnecessary talking down of our future economic prospects.
In the wake of the global financial crisis, global monetary policy was best defined by the three S’s, being synchronised, sizeable and successful. Now, for the UK, we need to focus on these three S’s: sequence, scale and sensitivity. This means getting the sequence right between hikes and withdrawing QE, a gradual scale of tightening and that policy makers need to be aware of how sensitive the economy and markets could be to this policy. This points to a gradual and predictable exit strategy that avoids policy shocks.
Productivity: will the UK experience a resurgence of productivity growth in 2018?
Productivity growth has the potential to recover, and I think it will. But I would not use the word resurgence, as your question does, as there is no magical solution to low UK productivity, but marginal improvements can make a difference. The UK has a productivity gap across regions, within regions, and within sectors too. Moreover, diffusion of productivity gains is low. That is, the benefits enjoyed by high productive firms or areas are not always shared more widely.
In my view, we can make progress by focusing on the four "I's" of incentives, investment, inclusivity and infrastructure. For instance, incentives matter, particularly to attract big firms to clusters, where similar firms in a sector can be based. Boosting local competitive advantage is key to building the clusters of economic power that help drive productivity growth. Also, the UK has invested too little in physical and human capital, including skills and on the job training. Inclusive productivity growth matters, to spread the gains. The UK has a large number of low-productive sectors, five of which account for one-third of UK output and close to half of jobs. Also, 'inclusive' relates to addressing the large regional variation, including the huge gap in productivity between London and other cities. We need to spend more, and sensibly, on infrastructure, led by the government and ideally by attracting long-term private sector savings. We are now making some good advances on infrastructure, but there is a long way to go.
You can read the full annual survey on the Financial Times’ website by clicking here.
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