My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.
The scores are in, and they show that Britain’s economy held up very well in the second half of last year, in the aftermath of the vote to leave the EU. I and many others expected weaker growth, and we have yet to see it.
Right to the last, with the 0.6% rise in gross domestic product (GDP) in the fourth quarter reported by the Office for National Statistics on Friday, the numbers surprised on the upside. The expectation was 0.5%.
And, while last year’s growth rate was the weakest for three years, it was the strongest in the G7, and far better than the overwhelming majority of economists expected in the immediate aftermath of the referendum.
The figures are a vindication for those who said that, while the medium and long-term consequences of Brexit would be significant, the impact on growth in 2016 would be negligible. This was the conclusion, for example, of the National Institute of Economic and Social Research (Niesr), in a May 2016 article, The Short-Term Impact of Leaving the EU.
The Treasury, which has a close relationship with Niesr, should have taken a leaf out of its book, though it was under political direction. GDP is the best overall measure of economic activity, though it has its critics and often fails to tell the full story.
The story we have is that in the final quarter of 2016, and indeed in the second half of the year. Buoyant consumer demand led to strong growth in the dominant service sector of the economy. That the service sector is dominant – its output in the final quarter was 1.8% up on the April-June quarter – was a good thing. Had we relied on manufacturing, overall industrial production, construction or agriculture, the economy would be in the doldrums. All ended 2016 with lower output than in the second quarter.
What else do we know? Employment growth has flattened in recent months and inflation is on the up. But this looks like a year in which the chancellor will not have to admit that the official forecast for public borrowing – the budget deficit - was too optimistic. Admittedly that forecast was revised up, to £68bn, in November, but figures last week suggested the deficit may come in below that, though still some way above the Office for Budget Responsibility’s pre-referendum forecast of £55bn.
How should we respond to the economy’s post-referendum resilience as we move from the phoney war over Brexit to the real thing? Though there is no evidence he ever said it, is this a good example of the dictum often attributed to Keynes: “When the facts change, I change my mind. What do you do, Sir?”
In one very simple sense, the economy’s resilience in the second half of 2016 has to change minds about growth forecasts for 2017. Non-economists may find this a puzzle, but the higher the level of GDP at the start of a year, the stronger that measured growth is likely to be for that year. This is because growth is measured on a calendar year basis – the average for 2017 versus the average for 2016 – and GDP starts the year 0.8% above its 2017 average.
Forecasters would also admit to other effects, however, and I would agree with them. Does the strength of consumer spending so far – the 52% celebrating and the 48% spending to ease their pain – tell us that the spree will continue? The Resolution Foundation think tank, in a report today, says the recent mini boom in living standards has ground to a halt because of rising inflation. But household borrowing, currently rising very strongly, could limit the spending slowdown.
We will not know for some time. Early evidence suggests some loss of retail momentum, with the official retail sales figures showing volumes down by 1.9% last month and this month’s CBI distributive trades survey very downbeat. But this could just be a temporary reaction to the strength of spending in earlier months.
Similarly, the extent to which businesses will reduce investment and recruitment, or maintain it, depends on whether they are reassured or concerned by the prime minister’s greater clarity on her Brexit plans. Article 50, and the invoking of it, has been seen as a significant moment for business. We will soon know whether it is.
Most economists who have taken a downbeat view of Brexit, are sticking to their guns. As Simon Tilford of the Centre for European Reform puts it: “The British economy has not weathered the Brexit storm. It is just that the calm before the storm has lasted a bit longer than many had assumed. There is no reason to think Britain will escape serious and permanent damage to its foreign trade and investment and hence living standards.”
Fathom Consulting, which will hold a seminar this week, “Brexit: a storm in a teacup?”, has come to the view that it most definitely is not.” Despite the economy’s resilience in the second half of 2016, its forecasts are resolutely downbeat, just 0.9% growth this year and 0.4% in 2018.
For Fathom’s Erik Britton and Andrew Brigden, Brexit has exacerbated the economy’s other weaknesses, notably persistent weak productivity. Last week’s industrial strategy green paper form the government identified the large productivity gap between Britain and our main competitors but without offering too much hope for closing it.
According to Fathom, weak productivity is not just a temporary post-crisis phenomenon but the new long-term condition. It is exacerbated by ultra-low interest rates, which prevent the process of “creative destruction” – getting rid of older inefficient firms and replacing them with newer and more productive ones – which drive productivity improvements.
In theory, the Bank of England could start the process of “normalizing” interest rates this week. The economy has been notably stronger than it expected when it made its emergency post-referendum cut in Bank rate to 0.25% in August. For a second time since then, it will revise up its 2017 growth forecast, currently 1.4%. It is much more optimistic than Fathom. The upward revision, and the prospect of sustained above-target inflation could provide the Bank with an excuse to reverse last August’s rate cut.
Will it do so? No. Simon Ward, an economist with Henderson Global Investors, has a statistical model that predicts what the monetary policy committee does. It “predicts” that four members of the Bank’s monetary policy committee (MPC) should vote for higher rates this week.
But, as Ward laments, “today’s MPC is a different animal”, with Mark Carney more dominant in its decision-making, and an early rate rise would be interpreted by his many critics as an admission that last August’s decision was a mistake. So it would be sensible not to expect a rate hike for a while yet.