ANALYSIS | Economic Outlook
Adam Chester Head of Economics, Lloyds Bank Commercial Banking E
ver since the EU referendum result, every scrap of new economic data has been scrutinised for evidence
of an uncertainty-driven slowdown. But, aſter an initial steep decline in July, economic activity has proved far more resilient than many expected. Taken together, all the indicators
suggest that economic growth in Q3 of 2016 – the first full post-Referendum quarter – could show a gain of as much as 0.4% quarter on quarter. That’s well above the Bank of England’s expectation in the August Inflation Report. The decline in business uncertainty
this effect. The National Institute for Economic and Social Research made headlines recently by predicting that the rate of inflation would increase from its current 1% to almost 4% by the end of next year as these depreciation effects followed through.
How households and companies will
react to higher inflation is going to be a key issue for economic prospects and also for monetary policy from the Bank of England. It is not that long ago that, in setting its policy interest rate, the Bank of England ‘looked through’ what, at the time, was seen as a temporary increase in inflation due primarily to rising global commodity (including oil) prices and held rates unchanged despite rising inflation. Two key issues will be whether higher inflation feeds through into higher longer-term inflation expectations and the extent to which it reduces real average earnings growth and with it consumer spending growth. These are likely to be a focus of interest in shaping economic prospects over the coming year, and will be of particular relevance to smaller businesses in terms of the pace at which they may see the demand for their services and products rise in a competitive marketplace. Q
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since July has also been telling, with September’s reading easing further from August, reinforcing suggestions of a more resilient outcome. We would, however, caution against concluding that the outlook has fundamentally improved. The first official investment data for Q3 is not published until late November, but so far surveys of investment intentions – from the CBI, BCC and Bank of England’s Agents – have all soſtened. Meanwhile, the first indications of the
government’s preferred timetable for the exit from the EU, and of its broad strategy, underline the risk of further economic upheaval. While only a moderate slowdown
is in prospect for Q3, the deceleration further ahead may prove more drawn out as a resurgence of uncertainty follows the activation of Article 50 by the government’s March 2017 deadline. Meanwhile, the weakness in sterling – down 16% since the referendum – is likely to drag on consumers’ purchasing power as higher import costs push up inflation, although currency weakness will also help boost net exports. The post-referendum currency
depreciation will be a key driver of the inflation outlook. Headline and core inflation were surprisingly low in August, but with sterling now trading around 22% below its 2015 peak, it is a question of when, rather than if further upward pressure on costs feeds through to prices. Imported goods in particular – including energy products and food
– are likely to see marked increases. We expect CPI inflation to reach 1.3% by the end of 2016 and pass the Bank of England’s 2% target in Q2 2017. The Bank’s August policy announcement delivered a multifaceted policy package, including cutting the bank rate to 0.25%, but was unchanged in September. However, the minutes of that meeting revealed that the Monetary Policy Committee’s view of the “contours of the economic outlook following the EU referendum” hadn’t been swayed by the economy’s resilience so far, indicating that a further easing in policy remains on the table.
Weakness in sterling is likely to drag on consumers’ purchasing power as higher import costs push up inflation
Our expectation is for the bank rate
to be cut to 0.1% at November’s policy meeting, though the probability that this gets delayed – or doesn’t happen at all – has clearly risen. In our view, higher inflation resulting
from the recent bout of currency weakness – with a larger drag on purchasing power – as well as the recent rise in market interest rates, both reinforce the case for further policy loosening, rather than reducing it. Whether any further stimulus will also be announced will be influenced by the content of Chancellor Philip Hammond’s Autumn Statement. His comments so far point to relatively limited ambitions for a fiscal stimulus. If the economic data continues to
be robust and the bank rate is cut in November, that would remove the need for further loosening of policy in early 2017. Q
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