Sunday, January 06, 2019
Mind the gap - this could be the year we fall into it
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.

We are just a few days into 2019, resolutions have already been made and broken, and many people have had a stab at predicting the outlook for the year. Forecasts are just forecasts, of course, and the real world can and does have a mind of its own.

In that sense, my piece a week ago recording that most forecasters had a good year in 2018, which generated much more than the usual interest, could be both a comfort and a warning. The comforting part is that forecasters do get it right. Less reassuring might be the thought that lightning does not strike twice.

While I am on that, many people, including my colleague Irwin Stelzer, have asked whether there is any consistency to the performance of the forecasters. I have been running my league table for at least a quarter of a century and, while I cannot promise to go back that far, I should be able to provide a running order for the past three3, five5 and 10 years. Watch this space.
For this year, consensus forecasts for the economy — as compiled by the Treasury each month — have been remarkably stable in recent months, despite the many political twists and turns.

They are for economic growth of 1.5%, a touch stronger than last year, and for inflation to head down to its official target rate of 2% (from 2.3% now) by the end of the year. Unemployment surprised on the downside last year and is expected to hold broadly steady at 4.1% of the workforce.

Britain’s balance of payments is expected to remain significantly in the red, with a deficit similar to last year, which I estimate to have been £85bn. I shall return to that in a moment. As for interest rates, the general expectation is that they will edge higher, with at least one, and possibly two, quarter-point increases from the current 0.75% level. Government borrowing is expected to edge up to about £33bn for the 2019-20 fiscal year, from £31bn in 2018-19.

These forecasts seem perfectly fair. I should say, as you have probably already noticed, that they are conditional on the prime minister getting something close like to her EU withdrawal agreement through the House of Commons and (though you would not describe anything related to Brexit as being smooth)) an orderly Brexit being achieved. This is despite the government’s stepping up its no-deal preparations. I: it cannot be long, amid the controversial chartering of ferries, before a minister invokes the little ships of Dunkirk.

On this basis, Samuel Tombs of Pantheon Macroeconomics predicts growth this year slightly better than the consensus, at 1.6%,; an unemployment rate of 3.9%; and inflation coming down to 1.8%. He thinks there will be a bounce in business investment if there is a deal, as do the chancellor and Bank of England governor (thoughI am a little sceptical). He also sees scope for a significant appreciation in the pound, to $1.40 and €1.27, from $1.26 and €1.11 now, partly on the back of a rise in Bank rate to 1.25%.

Narrowly second among the forecasters last year, the Office for Budget Responsibility (OBR), suffers from the disadvantage of not being able to update its published predictions as regularly as others,. Its latest forecast, at the end of October, was also for 2019 growth this year of 1.6%, and below-target inflation of 1.8%, and an unemployment rate of 3.7%. If my top two forecasters are to do as well this year as last, it will be by being more optimistic than the consensus.

All this assumes, as noted, an orderly Brexit. I cannot remember a time when the outlook for the economy has been so dependent on what happens in the first three months of the year. If we get over the Brexit line on March 29 Brexit line in a pragmatic and sensible way, prospects for the economy will not, by any measure, be great — we will still do worse over time than we would have done by staying in the EU — but they will not be terrible.

A no-deal Brexit, as I have rehearsed here on a number of occasions, is a very different kettle of fish. The OBR has drawn comparisons with the three-day week of 1974, when the economy recorded its biggest post-war quarterly fall of nearly 3%. Tombs, while stressing that a “calamitous” no-deal Brexit is highly unlikely, thinks it would lead to a slump in sterling, higher inflation, emergency measures from the Bank and a significant hit to growth. It is hard to argue with that.

There is an element of all this that it is worth dwelling on. There was a brief moment, after sterling’s sharp post-referendum fall, when it was possible to be optimistic about one aspect of the rebalancing of the economy, — the balance of payments current account deficit. Indeed, I wrote as much here.

It was, I am afraid, a short-lived hope. The current account deficit narrowed from an all-time record of £103bn in 2016 to £68bn in 2017, but it widened again last year. The latest figures we have, for the third quarter of 2018, showed a deficit of £26.5bn. As a percentage of gross domestic product, the deficit, 4.9%, is bigger than at the time of the Opec oil crisis of the 1970s or the Lawson boom of the late 1980s.

That matters, or it could. If you have a current account deficit, then you require offsetting capital inflows. Maintaining those inflows will be a challenge with any form of Brexit. Mark Carney once referred to Britain relying on the “kindness of strangers”, but strangers can be a hard-headed lot.

Keeping the capital flowing into Britain under a no-deal scenario would be likely to involve a significantly lower pound, allowing foreigners to buy up UK assets, including businesses, at bargain-basement prices, and/or higher interest rates. The balance of payments, which has not featured much in the recent economic debate in recent years, could yet return to bite us.

That depends, as I say, on what happens in the next three months, and whether our politicians steer clear of what would be a monumental blunder. Forecasters are assuming they will. Let’s hope that they are right.