Sunday, January 03, 2016
EU referendum is the biggest cloud on the horizon
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

The easiest thing to do when looking ahead is to assume more of the same. That, to let you into a dirty little secret, is how economic forecasting generally works and it is why economists are not bad at identifying trends but not good at predicting turning points.

It also keeps forecasts within realistic limits. Having ended the year at close to zero, you would put a very low probability on inflation rebounding to 10% over the next 12 months. Britain’s twin deficits – the red ink on the budget and current account – are not going to turn to surplus between now and the end of 2016.

The Bank of England’s monetary policy committee (MPC), similarly, will continue to adopt an ultra- cautious approach. After nearly seven years pondering whether the time was right for a quarter-point rise in interest rates, it will not suddenly start jacking them up as if there was no tomorrow.

Things do change in unexpected ways, however, even when they are flagged in advance. Britain’s continued membership, or not, of the European Union will come into focus this year. Even that, of course, is subject to some uncertainty.

We do not know for sure whether the EU referendum will be held in 2016, even though a summer vote appears to be David Cameron’s clear preference.

Assuming the referendum is held this year, we do not know whether it will be an economic non-event or the biggest challenge for Britain’s economy since the global financial crisis. Swap opportunity for challenge and you have both sides of the debate encapsulated. More on that in a moment.

As for the world beyond Britain, the world’s two biggest economies will, unsurprisingly, have the biggest influence. It may be that America’s presidential election is just a bunch of unelectable Republicans providing entertainment before Hillary Clinton’s stately passage into the White House but it cannot be ignored.

The Federal Reserve will raise interest rates further, perhaps as many as four times this year. Markets celebrated last month’s first Fed hike for nine years.

They might not do that every time, though if the Fed feels confident enough to continue the process of “normalizing” rates, it shows it is reasonably sanguine about the US and global economies.

As for China, its landing was hard enough last year to hit commodity and stock markets but in recent weeks the numbers have looked rather better. If you believe the official figures of growth of slightly below 7%, Chinese growth should stabilise around that level this year. That will provide a little support for oil prices. I cannot see a sustained drop in oil to $20 a barrel though I would be surprised to see a recovery to much more than $50.

America and China are not the whole of the world economy but they suggest a picture of reasonable growth; not as good as strong as the 4% trend rate of global expansion but 3.5% is achievable.

What about Britain? Before returning to the EU and the referendum, two things. The first is the argument that this recovery is so long in the tooth that we should be ready for the next downturn. We are now into the seventh year of a recovery that began in the middle of 2009. It sounds like a long time but the recovery that preceded it, from the early 1990s to 2000, ran for more than 16 years. The one before that, in the 1980s, lasted for over nine years. Given how far the economy fell in 2008-9, it is far too early to be calling time on the recovery.

The second thing is to deal with the end of year flurry of nonsense about Britain being in the middle of some kind of debt-fuelled consumer boom. In the national accounts released just before Christmas, the Office for National Statistics reported that aggregate wages and salaries in the third quarter were 4.6% up on a year earlier, pushed higher by both pay rises and employment growth, at a time of zero inflation. Real household disposable incomes were up by 4%. Consumer spending growth of 3% over the same period looks modest by comparison.

And, while household borrowing has picked up a little, it remains remarkably restrained. Overall borrowing has risen by less than 5% over the past seven years, and is significantly lower in real terms and relative to income than it was before the crisis. Unsecured borrowing is 15% lower in cash terms than before the crisis.

So what is in prospect? The big question about the EU referendum is not just the result but whether the uncertainty leading up to it has a significant impact, for example postponed or cancelled investment projects. My judgment is that there will be a little of this, but not too much. Despite the closeness of some polls, most businesses are assuming that the status quo will continue, and that voters will not choose Brexit. If that assumption, which I tend to agree with, turns out to be wrong, then the EU will be the big story for Britain’s economy in 2016. And, whatever your view of the long-term consequences of EU exit, the short-term effects would be significant, and negative.

In the absence of that, what is the outlook? If you took the pre-Christmas gross domestic product figures at face value, which suggested a slowdown, you would expect even slower growth in 2016. But, as I said last week, I did not, so growth of around 2.5% is on the cards for this year.

Inflation, having surprised everybody on the downside last year, should rise very slowly, as some of the helpful “base” effects drop out. But We may still be below 1% at the end of the year. I shall go for 0.75%.

Does that mean the Bank of England will leave interest rates unchanged? I am tempted to say so, conscious of the fact that for the past six years at this time the Bank has been expected to raise rates over the course of the following 12 months, only to do nothing of the sort. But, while fearing another error, there is a limit to the extent to which the Bank can ignore rate hikes by America’s Federal Reserve without at least a token move. So, with trepidation, I will say one move, to 0.75%.

Unemployment should continue to fall, to 0.7m on the claimant count, and just under 5% on the wider Labour Force Survey measure. The current account deficit will still be with us, as noted, but should drop to around £60bn, from nearly £80bn last year.

All that assumes that the economy in 2016 will not be hugely different from the economy in 2015. Meanwhile, the big issues, including productivity, the budget deficit, the EU and trade will continue to exercise us, or certainly me, in the coming months.