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What does 2018 have in store for the economy?

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Britain is set for modest growth this year, which will feel as if the economy is merely treading water. But the big story is a strong global economy, which is doing better than for many years, and this will limit the downside for this country and provide exporters with a fillip.

It is a feature of the early weeks of any January that, barely have we absorbed what happened in the old year, we want to know what comes next. There is a stock market rule that what happens in the first few days of the year will determine whether shares end the year up or down, and it has started well. When it comes to the economy, there are two useful principles.

One is that momentum is important. If the economy starts the year weak, then a poor year is not guaranteed but is more likely than not. The second is the impact of events. We are still dealing with the effects of political events, most notably Britain’s vote to leave the EU in June 2016 and Donald Trump’s victory in the US presidential election a few months later. The Brexit vote ushered in a period of slower growth in Britain, and one of the big questions is whether that will continue this year. Trump’s election, in contrast, was expected to be negative for America and the global economy but has been the opposite. The US economy is looking stronger than it has for some time.

It is the performance of the world economy which offers the biggest reason for optimism this year. Two years ago, the world was beset with what George Osborne, the then chancellor, described as a ‘dangerous cocktail’ of risks. The oil price was collapsing, emerging economies appeared to be teetering on the edge of crisis, and growth in the advanced world continued to disappoint.

Now things are very different. The global economy had one of its best years since the financial crisis in 2017 and looks to have the momentum to carry this forward into another good year in 2018. Oil prices have firmed, reflecting rising demand, and stock markets have boomed. After years of lopsided growth, driven by China’s expansion, the world is now firing on all cylinders. That means strong growth in America, in Asia, and what is turning out to be the biggest surprise, in Europe. Economists had got used to lacklustre growth, at best, in the eurozone. Now it is growing at its fastest rate for many years, with business and consumer confidence high. The world economy finally looks to be shrugging off the effects of the crisis.

This is important for Britain. Though last year was characterised by slower growth even as the rest of the world was accelerating, a stronger global economy limits the downside for the UK. It would be unusual to the point of unique for Britain to tip into recession while the rest of the world is strong. Prospects for growth in Britain are not strong, with a consensus this year of around 1.5% compared with 1.7% in 2017. That is not much better than treading water, though without the boost provided by the world economy it could be worse.

One reason for slow growth has been the squeeze on real wages resulting from high inflation, which in turn reflected sterling’s Brexit-related fall. Lord Wolfson, the Next chief executive, has predicted that clothing inflation will rapidly subside, though the main measure of inflation, based on the consumer prices index, is likely to fall only gradually from its current 3.1%. With wages growing at 2%, that means the squeeze will last for some time yet. The OECD predicts that Britain will have the weakest real wage growth this year of any of its 30-plus members.

Weak wages will hold back consumer spending, which has already slowed to its most subdued growth in more than four years, and Brexit uncertainty will cast a shadow over business investment. A couple of years ago, this was expected to be a period of strong growth in business investment, perhaps 6% or 8% a year. The good news is that investment has not collapsed but intentions surveys suggest it is on course to grow only modestly, by just 1% to 2%.

What is the outlook for interest rates and for fiscal policy this year? On rates, the Bank of England broke a ten-year duck in November by announcing the first hike since 2007, though the rise to 0.5% merely reversed the emergency cut it announced in August 2016. While weak growth would normally lead the Bank to stay its hand on further hikes, it is expected to announce at least one further step towards ‘normalisation’ this year. Some market economists expect two hikes, in May and November, while others think the Bank will leave it until late in the year before announcing a single hike.

How about fiscal policy? The year has started, not for the first time, with intense pressures on the National Health Service, in turn putting pressure on the government, and there is a definite air of austerity fatigue. Philip Hammond’s November Budget has not stayed long in the memory and it will be ten months until the next one. I would not expect much in the way of fiscal action before then.

That is unless we get another of those ‘events’ which will shock and surprise. Not so long ago, the consensus was that Theresa May could not last long after her summer election gamble failed. Now the view is that she has to last to avoid a Corbyn government. A 2018 election is unlikely but not impossible. The twists and turns of the Brexit process, meanwhile, will be closely watched by everybody in business, with the first priority securing a lengthy post-EU transition deal. The hope has to be that this can be achieved quickly and amicably. The fear is that political divisions at home and in Europe could make Britain’s path out of the EU a very rocky one. We will not want for interesting things to occupy our attention in 2018. Sometimes we might hope that they were a little less interesting.

Issue: 1382
Categories: Analysis , Brexit , Tax policy