Transcript - Episode 3: Outlook for growth

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Gaenor Bagley: Welcome to the third in our series of Beyond Brexit podcasts. Today we are discussing the outlook for the UK economy, inflation, growth, the Government’s industrial strategy and the possible impact of trade negotiations. I am Gaenor Bagley, PwC's Head of Corporate Purpose and I also chair our EU Steering Committee, and I’m joined by Andrew Sentance, PwC's Senior Economic Advisor.

So, Andrew, after the vote to leave the EU in June, it feels like the UK economy has held up better than expected. What do you feel is the short-term outlook for the UK economy?

Andrew Sentance: Well I think you’re quite right Gaenor, the UK economy has done much better than I think many economists expected, but actually as we look back on that I think we can explain it quite well.

First of all, the consumer has kept spending because wages have been increasing faster than inflation. The worries about uncertainty affecting investment are not yet coming through but they may still come through, and the world economy has held up reasonably well.  It’s also worth pointing out that the political situation, which looked very rocky after the referendum result, has actually stabilised. So it’s true that the UK economy has performed quite well in the last 6 months of 2016, but it’s still reasonable to expect slower growth in 2017 and 2018. So we’re expecting about 1.5% growth in those two years as inflation comes through and squeezes consumer spending. Investment uncertainty does have some impact on the growth of the economy.

Gaenor: Yes ok that’s interesting. So actually it’s shown in the short term we’ve probably been a little bit more resilient almost emotionally and politically than we thought and that’s had an impact on the economy. You mentioned inflation, so what do you think is the long-term outlook for inflation, do you see significant increases in inflation?

Andrew: We’re certainly set for a period of higher inflation than we’ve had over the last 2-3 years. Inflation came down to zero in the UK and in a few months it was actually even slightly negative a year or two ago. It’s gradually been creeping up, it’s now nearly 2%, it’ll probably go over 2% in the next few months and it is probably going to stick around about 3% in the second half of this year and going into 2018. It’s not going to be as high as we saw in 2008 and 2011 when inflation went over 5%, but the period of relatively high inflation could be quite persistent. That’s because it takes a while for the fall in the value of the pound to feed through the pipeline of costs and to come through to consumers in the high street or in terms of on-line purchases.

Gaenor: So that’s important isn’t it, because we talked about consumer growth buoying up the economy in the short term, so inflation could put a bit of a damper on that?

Andrew: Yes. Wage inflation has been picking up but it’s not likely to compensate for that rise in inflation from about zero up to three. So wage inflation has been going at about 2-2.5%, it’s crept up slightly higher than 2.5% but the gap between inflation and wage growth is going to be quite significantly squeezed.

Gaenor: That’s important isn’t it? We always talk about averages in the economy as a whole, but do you see any disparity between particular regions of the UK that will be impacted more than others?

Andrew: I think the influences that we see are going to operate across the economy as a whole. The three main influences are firstly, inflation squeezing consumer spending, that’s going to affect everybody. The second is in terms of investment uncertainty and again that’s going to be affecting businesses across the whole economy. Then third, the offsetting influence is how the world economy doing a bit better than expected, which is going to help support growth. But again, that’s going to feed into what’s happening across the economy as a whole. So I don’t think we’re going to see big regional and sectoral divergences.

Gaenor: The Government started to publish information about their industrial strategy, do you see that having an impact and maybe perhaps helping even out any disparities by region?

Andrew: Well I think the Government’s industrial strategy is very sensible. It’s trying to improve the conditions for business across the country as a whole. There are some regional dimensions too it in terms of supporting infrastructure which hopefully will benefit connections to the north of England and other outlying regions. But it’s what I would call a ‘horizontal industrial strategy’, that means improving the sorts of things that all businesses might benefit from like skills, infrastructure and not trying to target specific sectors. In the past, in the 60s and the 70s, we had an approach of trying to pick winners and intervene in specific sectors, that’s not what the Government has got in mind and I think that’s consistent with economic thinking. So it’s a good thing but I think we have to be realistic about the delivery and the impact of this industrial strategy. Anything where government is trying to change the conditions of the business has a very long term effect. If you think about education and skills, if you improve the education and skills of the workforce it takes quite a while to feed through into the productivity of workers. So this is quite a long term thing and the worry that you would have is that in a few years’ time we have another shift of emphasis in a different direction, so it has to be pursued over a long period and delivered ultimately.

Gaenor: Yes, ok, so that’s always a difficulty isn’t it, balancing the short-term and long-term, which businesses are grappling with all the time. So what sort of economic data do you think businesses should be tracking? What’s going to be the really important ones for them?

Andrew: Well I think in the short-term one of the things that we think is going to change the outlook for the UK economy is inflation. So the extent to which inflation goes up and how long it stays up will determine how big the squeeze in consumer spending is. I think businesses will want to look at that both in terms of the impact on consumers but also in terms of making sure that their wage increases are competitive.  If they’re in an area of the labour market where there are skill shortages that could be an issue. I think the growth of the UK economy is always something that you want to follow, but also the growth of other economies around the world. The UK is a very international economy and how we do ultimately depends very much on how well the world economy does. So if the world economy goes through quite a reasonable growth period that’s going to take the edge off these Brexit concerns and help the UK economy get through a period of additional uncertainty.

Gaenor: So we’ve produced some long-term forecasts haven’t we that show long-term, relatively speaking, the UK should do relatively well in the long-term. Presumably that critically depends on what trade negotiations we actually end up with?

Andrew: Absolutely, I mean those forecasts are conditional on the UK getting a reasonable free-trade agreement with the rest of the EU and our trade arrangements not being too heavily disrupted by the Brexit process. And if that’s the case, we then see the traditional strengths of the UK economy such as being a flexible place to do business and attractive to international investment. Those support our growth in the longer term and so while the UK is going to move down the ranking of countries as other economies like India and Indonesia become more important, and China obviously is set to become the largest economy in the world, we will still be one of the better performing western economies when we get to 2030.

Gaenor: Ok that’s interesting. And what about the state of public finances? We have the Budget coming up later in the month, is that going to give some freedom if the economy has been a little bit better for more investment by the government.

Andrew: Well the Chancellor ahead of the Budget did get a bit of a boost from better borrowing figures and he’s actually got a bit more room for manoeuvre. I wouldn’t be surprised if he uses a bit of that in the Budget because the Government want to do everything that they can to keep confidence relatively high for consumers and businesses, so a bit of additional tax reduction on a selective basis could well be on the cards for the Budget.

Longer term the influences on the public finances are a bit more uncertain, we could face quite a big bill for the exit of the European Union and so we don’t know how that’s going to pan out. Obviously it depends on how much growth slows down over the next couple of years that could have an impact. But I think the Chancellor’s actually got some of the bad news on public finances out of the way, that came in the Autumn Statement, and so there is some scope for public finances to do a bit better than expected.

Gaenor: So a little bit of good news but still, I’m still hearing an overall message of it’s quite uncertain in the short-term. Long-term probably steady, but short-term probably keep a look out for regular data because it’s going to be a bit up and down between now and the next couple of years?

Andrew: Yes, I think we’re going through a period that is really uncharted waters you might say, of these Article 50 discussions and where they’re going to end up. And there’s also the possibility of additional turbulence in other countries. So we’ve got the French elections coming up, German elections coming up, Dutch elections coming up. We’ve got a new president in the United States, we’re not quite sure how he’s going to respond and perform. So there’s quite a few areas of uncertainty, it’s not just Brexit, it’s a situation more generally in Europe and in the United States.

Gaenor: Thank you. So I think from there we’ll probably have more than one conversation as things develop because there’s clearly a lot that’s really relevant for business that’s going to be changing almost day-by-day possibly as the political environment changes.

Thank you Andrew for your insights and thank you everyone for listening. We’ll continue to discuss these issues in more detail over the coming weeks. For more insights from PwC on Brexit please visit pwc.co.uk/brexit.

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