12 January 2016

UK Outlook Panel Debate

Martin Beck, Lead UK Economist, Oxford Economics
Neville Hill, Head of European Economics, Credit Suisse

As always at this time of year, our first evening meeting of 2016 focused on the UK economic outlook with Oxford Economics’ Martin Beck taking on Neville Hill from Credit Suisse. Beck kicked off proceedings by arguing that the UK’s economic cycle was already six years old - bearing in mind the post-war average this may mean we don’t have much longer in terms of growth before the next downturn. Still, Beck’s central view is that the expansion does have further to go - after all, there is still much spare capacity yet to absorb, on some estimates. In addition, an upward sloping yield curve suggests the markets don’t expect imminent recession either, though the reliability of this as a predictor is questionable.

The Phillips curve looks to have shifted down, with wage growth much lower for any given rate of unemployment than in the past. This could be due to inflation targeting, but also because of the strong growth in labour supply thanks to inward migration and older age cohorts remaining in the workforce. Productivity is showing tentative signs of improvement - possibly helped by strengthening investment as the cost of capital begins to fall relative to that of labour - which in turn could also be helpful for the wage/unemployment trade-off.

There are, however, a number of risks according to Beck. First, the current account is large (but financeable in his view), presenting a risk to sterling. Secondly, Brexit. It is questionable whether a referendum can be held this year, and while EU membership has probably helped support UK growth he believes this argument may have been over-stretched. The third risk is for a renewed credit boom. Though for the time being real household & firms’ debt growth has been modest. Fourth, official interest rates are not high enough to deal with a future downturn, and the QE channel may also be less effective going forward.

In conclusion, Beck argues we need looser fiscal policy, better BoE communication (with reference to interest rate rises) and a reformulation of monetary policy to focus on more than just inflation (something that our next speaker also agrees with, arguing that the Bank should focus less on inflation than the current framework requires).

Neville Hill began by noting the consensual views on UK economic growth this year and next. But is the analysis behind continued robust growth sound? Hill addresses this question by arguing that we might be focusing too much on real variables (especially in relation to the consumer); indeed, nominal growth is particularly weak meaning there may be little scope for profits and wages to grow.

In terms of the baseline view, the real economy - having accelerated in 2013 - is still robust despite recent business surveys pointing to a slowdown. Labour demand has been strong, again according to the surveys, but this has not generated much in the way of nominal wage growth. Core goods prices are likely to continue to fall according to Hill’s estimates, which - along with lower oil prices - have helped boost confidence, real wages and household spending. Despite volatility from China, Hill sees the external outlook improving too, particularly in the euro area - a critical export market for the UK.

So far so good, but pay growth has slowed, nominal GDP growth has been revised down (halving over the past year) and corporates are bearing the brunt as firms’ earnings growth has slowed dramatically at the expense of labour income. Weaker profits have been focused in the manufacturing sector, possibly due to sterling’s appreciation over recent years, with corporate margins being hit. Indeed, since WWII the main contributor to UK recessions has been the corporate - as opposed to the consumer - sector.

Hill concludes by examining the risk that the UK (and US) could now be “late cycle” - with the risk to his (and that of consensus) generally positive forecast for growth being for a corporate-led recession. Finally, Brexit could precipitate a sharp fall in sterling especially given the large current account deficit (which raises the risk of financing drying up quickly) with both demand and supply being hit in the event, thereby reducing trend growth.