Ignore the doom-mongers – here’s why the UK economic outlook remains good

Ignore the doom-mongers – here’s why the UK economic outlook remains good

The Liverpool Research Group in Macroeconomics – adopted by Economists for Free Trade before and since the EU Referendum – has updated its forecasts for the UK economy. This Group was the only serious economic body to have forecast correctly the economic implications of a Leave vote.

In July 2016, following the referendum, others forecast a recession in the second half of 2016, followed by 0.5% growth in 2017 whereas notoriously the Liverpool Group said growth would remain unchanged in the 2-3% range. Current figures show growth did indeed remain in this 2-3% range in the second half of 2016 and looks set to remain there through 2017.

Once again, other forecasters are failing to understand the implications of Brexit: this time the Brexit devaluation. Every student of the open economy knows that devaluation is a stimulus to the economy, raising profits on exports and reducing imports, and so pushing up home output, while also reducing consumer demand to make room for these extra net exports. The next section explains this in more detail.

But instead of explaining this, the great run of forecasters, including latterly the Bank, have banged on about slowing consumption and feigned surprise at buoyant producer surveys. It is as if the forecasting community is determined to prove it was right about slowdown and recession, just a bit wrong on its timing. But this zeal for self-justification will likely cause them trouble yet again.

In summary, the latest analysis from the Liverpool Group predicts:

  • Continued steady growth, with demand shifting more towards net exports
  • Consumer spending moderating as part of a standard expenditure switching response to the devaluation of Sterling
  • Investment growth pausing until current capacity is absorbed
  • Monetary policy remaining relatively easy in the short term but interest rates rising over the next 12 months

Fortunately, as US growth continues to be steady and the Fed is continuing to raise interest rates, we are likely to see some normalisation of money markets over the next two years. Continued excess capacity in raw material supply will keep raw material prices low creating a good growth climate for the next decade, as shown below.

Summary of Forecasts

Source: Liverpool Investment Letter, May 2017

Understanding the Impact of Devaluation in the Forecast

The sharp devaluation that followed Brexit was, in part, a response to uncertainty but mainly it stemmed from the need to penetrate new markets in order to sell more goods. The uncertainty was with regard to policy on many aspects of the economy, which after Brexit would be determined by the relatively unknown preferences of the UK government instead of the well-known ones of the EU. Nevertheless, as Mrs May’s government has got more and more into the saddle, it has become clear that it will pursue free trade abroad and be rather sensitive to worker needs at home — a combination that is easy for markets to appreciate.

The need to penetrate new markets as a result of devaluation has three main implications:

  • Productivity will rise and more goods and services will be produced; these must be sold.
  • There may well be some protectionist action from the EU, which could reduce EU demand for some UK products; this will need to be diverted to new markets. However, given Sterling’s devaluation, this effect is easily exaggerated.
  • There is the existing current account deficit that needs correcting and since this is in addition to the first two factors, it has swung into focus after some years of neglect. This deficit will worsen in the short run as free trade policies lower import barriers and so encourage imports.

All these factors point to the need to make UK products more attractive worldwide to generate bigger export sales. The Liverpool long-term trade model forecasts this as happening without any need for export prices to fall in the long run, because world markets are highly competitive and in principle will easily absorb the small incremental UK supply of exports; so in the long run the exchange rate will tend back to its previous level. Nevertheless, in the short and medium term, there has to be a factor pushing open this door; this is the exchange rate. It is playing its necessary role in the UK economy as vigorously as ever.

All the evidence from recent indicators tells us that devaluation has indeed stimulated the economy substantially. A devaluation of 15% is the external equivalent of a 15% surge in the money supply: indeed the two things should accompany each other over time. It is a strong monetary stimulus that works through the external channel in the first instance: whereas a monetary stimulus in the form of lower interest rates and more money printing works through the domestic spending channel.

A Resurgent Export Market

The evidence for exports resurgence is all around us. We are seeing strong CBI export survey returns and also strong Purchasing Managers Index reports in all sectors. Thus, demand is coming from exports and from import substitution. The domestic consumption component that was strong in 2016 is weaker in 2017, again a result of devaluation, which transfers income from consumer pockets into corporate profits.

Given that the economy must divert output into export markets and away from imports, we should expect this pattern of demand and supply. Output growth remains strong, even if the first quarter may have slowed a bit. April surveys suggest the second quarter will be stronger and we also expect some upward revision of the first quarter as more data comes in on net exports.