Sunday, January 01, 2017
Peering through the fog of 2017 uncertainty
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

A new year is upon us, and with it the challenge of trying to plot a path through the uncertainty. That there is more uncertainty than usual is not in doubt, as is the fact that there is a range of possible outcomes – good and bad – for both Britain and the global economy.

Forecasting, meanwhile, has become more challenging. Even for those who correctly guessed the outcome of the momentous political events of last year, predicting the market and economic response to them was another story.

I thought, rather than getting bogged down in precise numbers for growth, inflation and other economic magnitudes – don’t worry there will be plenty of those in columns to come shortly – it would be useful to sketch out some broad themes.

The broad themes that will occupy us over the next 12 months, and no doubt there will be more, are Brexit, European politics (and the interaction of the two) Donald Trump’s America and China )and the interaction of those two too).

Let me take them in turn. In the next few months we will move from the phoney war on Brexit to the actual process. Theresa May, who has promised a big speech soon setting out the government’s priorities – it would be unwise to expect too much detail – remains committed to triggering article 50 by the end of March, whatever the Supreme Court decides.

The logic of that timetable, that we will clear the formal two-year Brexit process in time for us not to have European parliament elections in 2019, and well ahead of the 2020 general election, is not that strong. It will be better to have a proper strategy in place than rush it. But, one way or another, it is reasonable to expect article 50 to be triggered in the coming months. That in itself is testimony to how rapidly events have moved. This time last year we did not even know for sure whether there would be a referendum in 2016.

There are two key questions for the post-Brexit vote outlook for Britain’s economy as the process gets underway. One is the response of consumers to higher inflation and the expected squeeze on real incomes. There is some anecdotal evidence, including from the Bank of England’s regional agents, that some people have been bringing forward buying ahead of expected price increases. But the big picture lies elsewhere. When we had a bigger squeeze on real incomes than is in prospect this time, between 2010 and 2012, consumer spending slowed to a crawl.

Whether it does so this time depends partly on the second question; the ability of the government to keep business on side as it embarks on Brexit, and thus to maintain confidence. If not, we can expect weaker recruitment – already evident in the official labour market numbers if not in the surveys – and business investment.

There is a plausible argument that the real issue for business comes later, with the question of whether there will be a “cliff-edge” exit from the EU in 2019 accompanied by the immediate imposition of tariffs. But there will be uncertainty ahead of that, including this year, and with the notable exception of Nissan, the government has so far done a poor job of reducing it.

The Europe Britain will be leaving could, of course, be a moveable feast. How much will this year’s elections change it? The link between politics and economics can be seen clearly in the problems for Italy’s Monte dei Paschi bank – and others – following voters’ referendum rejection of constitutional reforms.

The March election in the Netherlands, where the anti-EU Party for Freedom is ahead in the polls, could result in an in-out referendum there. France’s presidential election, the first round of which will be on April 23rd, is another significant political event. Germany’s autumn election will follow, and will be a significant test for Angela Merkel, not least after recent events in Berlin.

My working assumption is that the Netherlands, a founder member of the EU, will not be leaving. As Capital Economics puts it: “There is little chance of March’s Dutch election resulting in a referendum on EU membership.” The far-right party only commands just over a fifth of the vote.

In France, Marine Le Pen of the National Front should get to the second round but lose, probably to Francois Fillon. A weakened Angela Merkel should still be German chancellor at the end of the year. That assumes the political forces that forged 2016 spread in only a limited way to Europe. But life, as we have seen, is full of surprises.

When it comes to America, the Trump surprise has led most forecasters to revise up their short-term projections for US growth, though few expect a doubling of the growth rate, but also to expect more interest rate rises from the Federal Reserve. Both seem plausible. If aggressive tax cuts and a big infrastructure programme do not result in stronger growth then something has gone wrong somewhere, and small rises in interest rates should not get in the way too much.

Consensus forecasts for US growth this year are still quite modest, 2.3% versus 1.6% in 2016. The risks, as Oxford Economics puts it, are to the upside, largely resting on how aggressive the Trump fiscal expansion is. It sees the strengthening of the dollar as a result of “Trumponomics” pushing the euro down to parity with the dollar by the end of the year. Sterling is likely to come under further downward pressure against the dollar.

Oxford Economics has a useful grid to assess the president-elect’s impact. Its baseline is tax cuts eventually worth $1 trillion (just over £800bn). The upside would be $2 trillion, the downside a “mere” $500bn. Similarly for his infrastructure plans. On trade, its baseline is only limited and targeted restrictions. The upside would be if nothing happens, the downside a serious escalation of protectionism.

This is where America runs up against the global economy, and China. Forecasts for global growth have been nudged higher in recent weeks, partly as a result of the outcome of the US election. China is predicted to grow by 6.4% this year and 6.1% next, according to the OECD (Organisation for Economic Co-operation and Development).

I remain sceptical of a spontaneous hard landing for China, fears of which were at their height a year ago, and may return. Yes, China has had a huge run-up in debt since the financial crisis, and that will come to a head at some stage. I would be surprised, however, if it was imminent.

The bigger risk to China comes from America, and the Trump administration. Chinese growth has had a fair wind for many years, on the basis that its re-emergence into the global economy had many more benefits than costs for the world as a whole.

US-Chinese friction, and Trump’s promise to pull out of the Trans Pacific Partnership, will not prevent China leading in Asia, and may cement its role. But it creates unpredictability for the world economy we could do without.