UK economy in 2018: steady growth tempered by Brexit politics

Forty years ago, Ian Dury and the Blockheads released Reasons to be Cheerful, Part 3 – listing some of the better things in life as Margaret Thatcher became prime minister in the months following the winter of discontent.

Fast forward to the opening days of 2018 and fresh political tumult threatens to cripple Britain once more. There are, however, some reasons to be cheerful about the prospects for the UK economy. Despite the political to-and-fro of the past year, the UK economy enters 2018 in better health than many would have given it credit for.

The post-referendum recession never materialised. Consumers have kept calm and carried on spending against the odds, and global growth and a resurgent eurozone are helping to buoy British manufacturers.

Threats to this stability range from a collapse in Brexit talks to the biggest squeeze on living standards in generations and a slowdown in job creation, while political uncertainty will force businesses to delay much-needed investments to boost productivity. Captains of industry say the end of March is the deadline for a deal on the terms of transition to exit the EU. If that deadline is missed, they would be forced to make decisions that could have negative consequences for jobs and investment.

At the start of each year, economists make predictions for the path ahead, often to be proven wrong within a few months. With that in mind, here are three reasons to at least be a little bit cheerful about the UK economy in 2018 – with a handful of health warnings attached.

Growth won’t slow as much as feared

This time last year, the view was that growth would slow to 1% for the year. The UK hasn’t been able to keep pace with its biggest economic rivals and it is forecast to come bottom of the OECD league table next year as a result of the EU referendum result, but growth is now expected to be a reasonable 1.5% for 2017. It could have been closer to 2% without Brexit, according to some economists, but it’s far from the recession some envisaged.

This trend could persist into 2018, confounding the worst forecasts for the rate of expansion to slow closer to 1%. The consultancy Capital Economics reckons growth could be as robust as 2.2% in 2018, seeing few reasons why resilience among consumers to keep on spending should come to an end. That would come as a shot in the arm for the country, beating the gloomy official forecasts that Philip Hammond unveiled alongside his budget for growth of 1.4% in 2018.

Add the recovery in the global economy to the mix and Britain could find that a rising tide lifts all boats, no matter how battered they may be. Manufacturers stand to benefit from selling their goods abroad, helped by the pound’s weakness since the Brexit vote making British goods more competitive.

There may be trouble ahead, however, because businesses could put their investment plans on ice if concerns about the UK’s future trading rules with the EU linger. Households are also still facing higher inflation and sluggish pay increases, which could hold growth back.

The worst of the earnings squeeze will fade

British households have had a torrid 2017, seeing prices in the shops rise at rapid rates. This is because of the weak pound, which has pushed up the cost of importing goods to the UK. Wages have risen nowhere near as much.

The impact from sterling’s rapid devaluation is gradually being washed out of the system though, and the Bank of England reckons inflation probably peaked just above 3% in the final months of 2017 and is on track to fall in the coming months.

There are some indications of wage growth coming through – albeit slowly – as workers’ bargaining power to demand higher pay is lifted by the lowest levels of unemployment since the 1970s, and falling net immigration to the UK reduces the number of people in the workforce.

Britain is set to have the worst wage growth of any wealthy nation next year, however, ranking behind Italy, Greece and Hungary at the bottom of 32 OECD countries, as real earnings lag behind inflation. The Resolution Foundation has said the situation will improve toward the end of 2018, although it expects pay will remain flat over the course of the year once inflation is taken into account.

There are also worrying signs that Britain’s long jobs boom appears to be over, after an upward curve dating back to early 2012 which the Tories have been able to cheer time and again.

Official data is now showing a drop. The number of people in work across Britain fell by 56,000 during the three months to October to stand at just over 32 million. It could get worse, too. The Office for Budget Responsibility expects the unemployment rate to rise over the next five years.

Interest rates will stay low

Given the uncertainties facing the UK economy as Brexit talks intensify, the Bank of England looks set to sit on its hands in 2018 – which will help the most hard-pressed households with cheap borrowing costs. At most, interest rates may be nudged higher from 0.50% to 0.75%.

Assuming the talks with Brussels don’t lead to any major falls in the pound, the impact from sterling’s devaluation after the Brexit vote on inflation will gradually decline over the course of the year. The Bank has a target of 2% for the consumer price index, and rates are set to fall back gradually in this direction from a peak of 3.1% in November.

Should there be a move higher, it will only be limited and gradual, according to the Bank’s governor, Mark Carney, and it should be manageable for most. Just a third of households have a mortgage on their home and the majority have a fixed rate deal, meaning they will not see any immediate change until the term of their mortgage comes to an end. Those feeling the change will only see an increase in debt servicing costs of about £15 a month from a 25 basis point increase in rates, according to a Bank study.

One element to watch for as 2018 wears on is Carney’s impending departure in June 2019. City investors and politicians will start to clamour for clarity on his replacement, which could lead to uncertainty over the direction of monetary policy. Borrowers, under pressure because of slow wage growth and the rising cost of living, will need to stay alert.

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