Much to be positive about
What should we make of the prospects for the UK economy just over a month into what promises to be another eventful year? On the face of it there’s much to be positive about.
Growth has proved surprisingly resilient since last year’s EU referendum and the Bank of England’s latest forecast points to a stronger outlook for 2017 than we had predicted last November.
That more positive picture is the product of several factors, including a boost from the Chancellor’s Autumn Statement and a brighter outlook for the global economy.
It’s also been helped by the low cost of borrowing for households and businesses, plus the benefits to trade from the big drop in sterling we saw in the second half of 2016. And so far households have not cut back their spending even though the cost of living is beginning to rise.
Perhaps it’s no surprise that, when I visit businesses around The South East and East Anglia to talk to them about how they’re doing at the moment, many are quite positive.
Construction companies report some improvement in areas such as house building, road infrastructure, student accommodation, the care sector, leisure parks and shopping centres.
In the services sector locally many companies have shrugged off the post-referendum gloom and are reporting strengthening levels of activity.
Retailers reported a decent Christmas, especially those with an on-line presence.
Overall, however, it is a mixed picture. For example, there’s some uncertainty about the post-Brexit landscape, particularly for those companies that rely heavily on international trade, and some investment plans have been affected, which could drag on growth over the coming years.
It is clear that the UK’s new relationship with the EU – and the reforms that it brings about – will determine the country’s long-term prosperity.
In the nearer term, the Brexit vote will have a big impact on how much we pay for goods and services as last year’s drop in the value of sterling pushes up import prices.
We’ve already seen prices rise, and they will continue to do so - the Bank expects Consumer Price Index (CPI) inflation to peak at 2.8 per cent in early 2018.
This will inevitably eat into people’s incomes, squeezing households’ spending power.
This is part of the reason why the level of GDP is still expected to be 1.5 per cent lower in two years’ time than the Bank had projected last May.
So the Bank’s Monetary Policy Committee faces a difficult balancing act – how to keep inflation under control without risking higher unemployment.
Announcing their latest decision last week – to keep interest rates at their historic low level of 0.25 per cent – the committee judged it was appropriate to allow inflation to remain high for a period to support growth and jobs.
But they also noted that above-target inflation can only be tolerated for so long.
So they will watch the economy closely – in particular patterns in wage growth and household spending – over the coming months.
For example, if spending slows more abruptly than expected as prices rise and wages fail to keep pace, more supportive measures might be needed such as a further cut in interest rates.
But if pay growth picks up more rapidly – which might lead to further inflationary pressures in the economy – then it may be necessary to move policy in the other direction.
Last August, the Bank announced a series of policy measures to support the economy during a period of heightened uncertainty, including a cut in interest rates.
It appears that stimulus has played a part in keeping the economy ticking in recent months and some of that uncertainty has been mitigated.
This is unquestionably good news. But the Brexit journey is only just beginning, and there’ll no doubt be more twists along the way.
Assisted by the eyes and ears of the Bank’s agents in and around the UK, the Bank’s policymakers will react as required to help steer the economy through as smooth a course as possible.