Investment Clock insights

Economic times

Ian Kernohan

10 June 2015

Ahead of the recent UK election, there was a real risk that political uncertainty would begin to impact on the behaviour of firms and households, dampening economic activity. This potential source of uncertainty has now been removed and should give a boost to confidence. Business surveys and labour market data suggest that the UK economy remains in a strong upswing: unemployment is falling, churn within the labour market is rising (more job-hopping), real household income growth has been boosted by lower inflation, while activity in the housing market has stepped up a gear. With eurozone data pointing to recovery, better economic conditions in what is still the UK’s largest trading partner, should also be a benefit.

Inflation has turned negative, although much of this is down to the collapse in energy prices, which is actually a major positive for economic activity. At any rate, the effect of cheaper oil on headline inflation should drop out of the year-on-year comparison by Q4, pushing CPI (Consumer Price Index) back towards target.

There are of course downside risks to the outlook. The final coalition budget signalled that the pace of austerity was about to increase and would likely act as a constraint on growth, at least in the short-to-medium term. During the past five years, Mr Osborne has shown himself to be more flexible over pace of austerity than many expected, and no doubt the same will apply this time around. Low government borrowing costs should allow a less draconian fiscal stance than current plans suggest. A revised budget is due at the beginning of July.

The referendum on membership of the European Union, due to take place before the end of 2017, will also be a downside risk to corporate investment activity, if it leads to a rise in general economic uncertainty. At this stage, we cannot say for sure whether “Brexit”, if it happens, will be “bad” for the UK economy, since much depends on the terms of any exit.

With economic growth still buoyant, we think a rate hike from the Bank of England is still very much on the cards, although not until inflation begins to pick up and after a similar move by the US Federal Reserve, which we expect to happen by the autumn. We do expect the bank rate to rise, but only very gradually (1% end 2016) and gilt yields to stay below 3%; this should help to provide a supportive monetary backdrop for economic activity.

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