David Smith: "Economy has fair momentum despite the uncertainty"

Published:  17 June, 2016

David Smith, economics editor of The Sunday Times, told delegates that the economy was vulnerable, but still had fair momentum, at the 2016 NMBS All-Industry Conference.

With the EU Referendum vote now just days away, Mr Smith's speech naturally focused on the uncertainty that lies ahead regardless of whether the UK votes to leave, or remain in, the EU. The UK economy has been undergoing a slowdown in recent months, impacted by volatile markets and weak global growth.

Signs of this slowdown, Mr Smith said, began in January when the FTSE100 index fell by 20% compared with its peak in April 2015, amid what he described as a "torrid" start to the year, with oil prices collapsing and markets slowing down across the globe.

While Chancellor George Osborne's March 2016 Budget was intended to help calm things down, it in fact made little difference, as protests over the two major measures announced meant they were quickly scrapped.

The UK's economic recovery from the recession began in mid-2009 and has continued over the years since, albeit with a few bumps along the way. The best year for economic growth was 2014, where GDP increased by 3%, but Mr Smith noted it has still been a weaker recovery than was seen following previous recessions.

A key point of good news that Mr Smith highlighted included the high rate of employment, which has seen very strong growth with a record proportion of the working population (considered to be those between the ages of 16 to 64) now in full time employment. This has risen sharply in the last two years, with much of the work being among what Mr Smith described as "good quality" jobs.

However, productivity between 2012 to 2015 has been weak, and remains so, something he said was a real risk factor as, without productivity, you can't have sustained, long-term prosperity.

The service sector has largely led the economic recovery and continues to do so, with the construction, manufacturing and industrial sectors having a more mixed path back to growth.

Low oil prices, which historically have always been a boost to growth, have failed to be so this time. Oil prices were $110 a barrel in 2014, but fell to $29 and have now seemingly stabilised at $50. However, Mr Smith believes the rise in 'real' incomes that often occur as oil prices and, consequently, household costs fall can often take longer to be realised, and so he said this is probably coming, but is simply not here yet.

The Purchasing Managers Index (PMI) shows that the UK economy has generally been slowing since 2014, with the Construction PMI now at its weakest for three years. Mr Smith said new housebuilding has largely driven the recovery, but that the latest NHBC figures show that may have started to level off. He was quick to point out that it is the rate of increase that is less than it was, rather than the rate actually falling.

It seems clear that the worry and uncertainty around the EU Referendum is having an effect, and some companies anecdotally seem to be postponing decisions and recruitment, and generally being more conservative in their approach to their business until after the referendum vote is revealed.

Despite this, the recovery still has a fair momentum , with growth forecasts of around 2% per year being issued by the Bank of England, if the UK votes to remain in the EU. The Bank's forecast if the UK votes to leave is a little less certain.

Alongside the possibility of a 'Brexit', other vulnerabilities to the UK economy include:

  • The large current account deficit, which was 7% of GDP in Q4 of 2015
  • The Budget deficit, currently 4% of GDP
  • An excessive reliance on consumer spending
  • Weak productivity.

Mr Smith expects the bank to keep interest rates low for some time to come, though he said if the economy falls sharply, such as after a UK vote to leave the EU, they may have no choice but to cut the rate further. He said the Bank of England is not keen on this, though, so it would likely be a last resort move, given that the current rate is just 0.5%. Introduced as a temporary measure they said would not last a year, this rate has in fact been held for seven years - the longest time the rate has been kept the same since World War Two.

For interest rates to rise, the Bank of England has said it would need stronger annual growth of nearer 3%, wage growth of between 3% and 4% (currently 2.5%), and inflation back nearer its target of 2%.

Mr Smith believes the earliest rates will rise if we stay in the EU is October this year, and that's only if we see a sharp economic jump following the vote. The Office for Budget Responsibility has forecast rates will not rise until 2019, though Mr Smith said he thinks it may be slightly earlier than this, but that low interest rates are "the new norm", and it's unlikely the country will return 5% or 12% rates seen previously, anytime soon.

Mr Smith refrained from asking delegates in the room which way they would vote in the referendum, but did instead ask for a show of hands of who thought leaving the EU would be bad for their businesses, to which the vast majority said yes.

Mr Smith said that there was likely to be a short-term shock and political, economic and financial crisis if the UK leaves. He highlighted polls pointing to a fall in GDP of between 2 and 8% following a leave vote, compared to the GDP if we remain, but acknowledged some felt that would be worth it to have the UK out of the EU.

He said the current short term consumer confidence, which is higher than it has been for 40 years according to GfK figures, helps the remain campaign, but that high migration figures and the opinions appearing in many of the tabloid press helps to boost the leave campaign.

Ultimately, he said he thought it would be a close vote, but that 'status quo bias' and a generally risk-averse public would mean that, on the day, the UK may well vote to remain.

When questioned about what would happen if we do vote to leave, Mr Smith said he thought it would definitely hurt those businesses who are internally integrated across the EU, because even if everything else stays the same as negotiations begin, the decision itself would have an impact, with businesses who hate uncertainty postponing investment and the UK becoming a different proposition for international investors, especially in the financial sector.

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