On Wednesday (23rd November 2016), UK Chancellor Philip Hammond presented his first Autumn Statement. This provided the OBR’s first assessment of the impact of the UK’s decision to leave the EU on the economy, and on its public finances. Growth next year has been revised down, driven by much weaker expectations for business investment.
The OBR has cut its central projection for UK economic growth in 2017 by 0.8 percentage points to 1.4%, compared to the 2.2% that it had forecast at the time of the March Budget. 2018 growth projections have been revised down by 0.4 percentage points, in line with our own revision.
The majority of these downward revisions come from a much weaker path for business investment. Business investment growth in 2017 has been revised down by 6.3 percentage points from 6.1% to -0.3%. Implicitly, the OBR finds this is the main channel by which the decision to leave the EU will affect the UK economy. This is similar to our own thinking. We also believe the slowdown will come through initially in the form of weaker business investment.
Having looked at recent investment intentions surveys, and having considered the pace at which investment has responded to previous negative shocks, we have adjusted our profile for business investment growth, and for overall economic growth, since we finalised our latest quarterly forecast (GEMO 2016 Q4) back in October.
We have revised our forecast for the final quarter of 2016 from a mild negative to a small positive, but expect growth to be slower further out in 2017. Our assessment of the amount of time that business investment takes to respond to a negative demand shock suggests that the largest impact on business investment is felt two to three quarters after the event. Largely, we expect the low rates of productivity growth in evidence since 2008/09 to persist. Consequently, we now expect UK GDP growth to be a little under 1.0% next year. That is still a little below the consensus forecast of 1.1%, and some way below the OBR’s forecast of 1.4%.
The main difference between our own forecasts, and those of both the OBR and the consensus, is likely to be in our different judgments about trend growth. Fathom’s view is that dismal productivity growth post-crisis means that trend economic growth is somewhere in the range 1.0%-1.5%. Uncertainty associated with the Brexit vote, combined with the fact that the UK has experienced several years of above trend growth, leads us to expect growth to be materially below trend next year.
Philip Hammond announced the creation of a National Productivity Investment Fund designed to boost productivity, rightly seen as the UK’s Achilles Heel. And yet the OBR has revised down its forecast for productivity growth in the near term, and made no change further out. Even these new forecasts are too optimistic in our view.
The Chancellor is probably correct in his assessment that the UK would benefit from higher levels of investment. Indeed, as a share of GDP, the UK had the lowest level of non-housing investment across the G7 economies last year. Moreover, additional fiscal loosening is certainly preferable to additional monetary loosening if, as we suspect, the economy slows dramatically through next year.
Yet the impact of Wednesday’s policy announcements equate to a fiscal loosening of just 0.1% of GDP in 2017-18, rising to 0.4% of GDP in 2020-21. This compares to the estimated impact of Brexit on the public finances of 0.5% rising to 0.7% of GDP over the same period.
In essence, the Chancellor is making all of the right noises in terms of investment and fiscal loosening, but the magnitude of his proposed solutions is, perhaps by necessity, too small. The impact of fiscal loosening is estimated to be less than the impact of the Brexit vote and the investment policies have made almost no change to the trend forecast for productivity growth – which remains optimistic in our view.
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