A look back on 2017
Back in January 2017, the economy had defied expectations and had actually performed reasonably well, especially compared to what many were anticipating in the immediate aftermath of the Referendum.
That said, with GDP coming in at 1.8% in 2016, this was still a notable slowdown from 2015, and we expected that trend to continue in 2017 on the back of a number of factors. We expected…
1) Consumer spending to dampen
With sterling’s depreciation only showing tentative signs of filtering through at the time, we expected 2017 to be dominated by the upward trend in consumer prices, and the impact this would have on consumers.
And we weren’t wrong. Inflation steadily ticked up over 2017. While we had anticipated inflation to peak at 2.8%, the rise in commodity prices towards the back end of the year – notably in oil – helped CPI hit 3.1% in November. This rise in inflation, combined with weak wage growth (which did, and continues to puzzle economists), meant consumers’ real incomes contracted, dampening consumer spending in the process.
2) Business investment to drag on growth
A further drag on growth was expected to come from business investment, which was set to be negative. Uncertainty regarding the future of the future UK/EU relationship, as well as political uncertainty on the continent (remember a certain Ms Le Pen?) was set to discourage businesses from making any large scale investments. We were forecasting flat growth.
Happily, business investment surprised us to the upside. While the uncertainty around Brexit remains (do we actually no anything more substantial one year on?), political hurdles in Europe were negotiated, and more importantly the synchronised recovery in the global economy continued throughout the year. Indeed the US, eurozone and China have all had stellar years, leading to a revival in capital markets. This has been evident in the official data as well as our own Manufacturing Outlooks.
3) Trade to contribute positively to growth
We expected trade, on the back of the sterling depreciation and healthy global demand conditions to reverse its recent trend and contribute positively to growth. This hasn’t materialised…yet. While exports have been rising healthily, the value of imports have been up at the same rate, leaving our trade balance broadly unchanged.
Overall then, this time last year, we were predicting the economy to expand by 1.8% in 2017. While we are waiting for final figures for 2017, it looks like we may have been a tad optimistic back then. Indeed, as the year unfolded we revised down our forecasts twice, as consumer spending slowed and inflation continued its rise. We now expect the economy will expand by 1.5% for 2017 as a whole.
What does 2018 have in store?
Okay so now onto the interesting stuff, what’s going to happen this year?
1) Consumer spending to remain subdued, but extent of this is dependent on wage growth
The squeeze on households, on the back of rising inflation and weak wage growth should moderate in 2018. We believe inflation has now peaked (famous last words), as the pass through of the sterling depreciation has become exhausted, and should recede in 2018. Higher energy costs, particularly from rising oil prices, should keep inflation above the Bank’s target however, and as a result the trend of weaker household spending will still be relevant next year. The extent of this, is naturally dependent on wage growth, which continues to provoke debate.
While there have been some tentative signs of wage growth recently, we will have to wait for hard data from the January pay rounds for any solid indicators.
We ourselves are forecasting a pick-up in wage growth, but not to the same extent as others, given Brexit uncertainty and the fact there is no quick fix to the UK’s longstanding productivity problem makes bumper pay packages unlikely in the coming year(sigh). This will continue to hinder consumer spending and the dominant service sector in 2018.
2) Business investment to grow, but weaker than one would expect given global economy
The notable change from last year comes from our business investment forecasts, which following the upturn in the global economy we now expect to make a slight contribution to growth in 2018. The majority of this growth is likely to come from export intensive sectors such as manufacturing, given that global conditions are expected to remain supportive.
The shift from last year, in which we had investment dragging on GDP growth in 2018 is recognition that businesses, while not particularly optimistic, have a greater idea about the future path of the economy, illustrated though the convergence in GDP forecasts. Businesses are therefore more inclined to make some investments on the back of this.
However that said, given that the global economy is “close to firing on all cylinders”, this is a weaker performance than one would expect, and we are not forecasting a strong showing from business investment, given that uncertainty is likely to be ramped up the closer we get to the deadline for leaving the EU.
3) Net trade to finally contribute to growth…
…we were saying this all of last year, so let’s hope it finally materialises. We have no reason to believe that that the current momentum in exports, on the back of a strong global economy, will disappear anytime soon, and with inflation set to recede the price of imports should stay stable.
4) Another rate hike…?
Clearly one of the greatest developments last year was the Bank raising rates for the first time in a decade. We do not envisage this triggering a significant cycle of monetary normalisation, and are only expecting one more hike this year, of 25 basis points, and coming towards the back end of the year. Crucially we hope any rate hike, comes on the back of hard data, particularly with regards to wage growth.
Given these factors, and to broadly reflect the continuing story of rising inflation, weak wage growth, and Brexit uncertainty, we are forecasting growth to slow to 1.3% in 2018. Below are our full forecasts for 2018.
Let’s see this time next year whether we were along the right lines…