Macro insights

Outlook – Look out!

A robust 2018

Overall, global economic activity has been robust in 2018, expected to record growth of 3.8% and its fastest pace in seven years. The US economy has underpinned this expansion with its own strongest performance (2.9%) in 12 years. Other regions have not been so strong. China looks set to have posted modest deceleration to 6.6% for 2018, but an underlying slowdown in infrastructure spending appears to have had a marked effect on close trading partners, including emerging markets in Asia and Latin America and even the Eurozone, where growth looks to have slowed to 1.8% this year.

Softer, slower growth ahead

The outlook for 2019 is for modest deceleration. US economic growth looks set to soften to 2.3% as fiscal stimulus fades. Significant policy easing from the Chinese authorities should cushion the blow of the US’s restrictive trade policies, but economic activity looks likely to slow to 6.1%. And Eurozone domestic demand looks likely to prevent material deceleration, but we forecast a slower 1.4% for next year. Meanwhile most emerging market regions look likely to broadly maintain the pace of expansion posted in 2018. Fears may begin to rise for a more material deceleration in growth in 2020, but the outlook for next year is consistent with solid, if slower growth.

Uncertainty has weighed on UK growth

What has been unusual for the open UK economy these past two years has been the relative divergence of economic activity from the global trend. Growth decelerated to 1.7% in 2017 and we expect 1.3% for 2018 – a nine year low - despite the stronger expansion of our trading partners. We attribute this idiosyncratic performance to Brexit uncertainty, which has weighed on business investment (annual growth down 1.9% in Q3 2018) and prevented the UK from capitalising on a weak currency. We estimate UK economic activity to have lost around two percentage points of GDP since June 2016, compared with output we would have expected based on the performance of other countries.

Brexit will continue to dominate the UK’s economic destiny

The precise path of Brexit will continue to dominate the UK’s economic destiny. The Withdrawal Agreement negotiated between the UK and EU would provide for a transitional exit and would likely see the UK enter into a customs union following transition, something that should minimise the cost of Brexit for many years. This would allow for some recovery in economic activity over the coming years (we forecast growth of 1.8% in 2019 and 2020) even as global activity softened. In an economy already operating without spare capacity, this would likely increasingly generate domestic inflation pressures and we expect the Bank of England to return to tightening monetary policy as soon as Brexit uncertainty passes. We forecast the Bank to raise the Bank Rate to 1.75% (from 0.75%) by the second half of 2020.

The stakes are high

But the risk that Parliament rejects the agreed deal is high. The UK’s tortuous negotiations have delivered a blueprint for Brexit that would regain control of migration – arguably the key desire of the Brexit-voting public – but one that fails to deliver Tory Brexit MPs’ hopes for de-regulation and a reorientation of global trade policy. Given the government’s relative political weakness, a Parliamentary majority may require opposition MPs to vote for economic certainty over political opportunism. A Parliamentary rejection of the negotiated deal would likely result in a political crisis that could involve a leadership challenge, General Election, second referendum - or all of the above. It would also risk the UK leaving the EU without transition, something that would deliver an unprecedented supply-side shock which would likely result in recession in 2019.

Shaping the years to come

These political developments will take place over the final months of 2018, but must play out in early 2019. Political decisions taken over this short period of time will determine the shape of UK economic performance for many years to come.

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