There seems to be no sense of buoyancy in the UK economy that economists are picking up in other major economies across the globe. While confidence rockets in the US, activity indicators surge across the Eurozone, and developing economies embrace what appears to be a global upswing, the UK economy seems subdued, and oddly detached.
The performance of sterling probably best captures how the broader UK economy is feeling.It buckled in the immediate wake of the EU referendum result and has remained in the doldrums ever since, trading some 15% or so below its 2015 levels. Although it took some time to become apparent, there seems little doubt that Brexit effects are beginning to drag on the UK economy. While exports have benefited significantly from the combination of weaker sterling and stronger global demand, consumer spending growth has weakened materially and this is a far more important driver of economic growth. Consumers’ spending power has been weakened by the rising cost of imports, and the willingness to spend on large-ticket items has probably not been helped by the uncertainty about what will happen to the UK after it leaves the EU.
Some relief, however, should be at hand this coming year. The rise in inflation is almost certainly a short- term phenomenon related both to sterling’s post-referendum fall and probably also the rise in global energy prices. There is a very good chance that this coming year will see inflation sliding lower again and in doing so it should relax its grip on consumers’ pockets.
And what of Brexit? There seems little doubt that the outcome of trade negotiations will be by far and away the single most important driver of UK economic growth in coming years. The global economist fraternity have presented a rather gloomy view on the outlook for the UK economy and certainly, if no deal is reached with the EU they may be right. But we still hold the view that the UK should be able to reach a constructive post- Brexit trade agreement with the EU which will work to the benefit of both economies. There is much more than trade at stake. There are important issues related to global politics and security that already bind the UK closely with the EU. And of course, unlike any trading agreement that has gone before, the starting point for negotiations is perfect alignment. We expect the proximity of the Italian General Election on the 4th March to impede progress towards a deal in the first half of the year, but thereafter, we think there is a reasonably good chance of a positive outcome for the UK by the end of 2018.
If we are right, the clouds that currently hang heavy over the outlook for the UK economy could begin to part in the second half of 2018.
Don Smith
Chief Investment Officer
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