Perhaps the only certainty in relation to the UK at the moment is that things look very uncertain. Longer-term, much will depend on just what Brexit ends up meaning. Shorter-term, most economists expect some form of demand-led slowdown – with general business and consumer uncertainty pulling back on investment and spending and sharp falls in sterling almost certainly pushing inflation higher over the next 12 months and thereby squeezing on incomes. However the magnitude of any such deterioration is highly unclear.
A sense of both the potential near-term impact and the scale of disagreement is provided in the Treasury’s first post-referendum collection of independent forecasts for 2016 and 2017, published today. With a few exceptions, the forecasts paint a picture of slower growth, weaker employment and pay growth slowdown. Below we set out the five charts that characterise the early expectations of what is to follow.
1. The economy looks set to be smaller than previously expected
Across the 26 post-referendum forecasts collected by HMT, 25 point to lower output in 2017 than had previously been supposed (accounting for the cumulative effect of the 2016 and 2017 revisions). This range implies that the economy will be anywhere between £6 billion larger (Liverpool Macro Research) and £78 billion smaller (Credit Suisse) than the same forecasters thought before 23 June.
Taking the average, the forecasts point to the economy being around £36 billion smaller than previously thought. Only five forecasters project a calendar year recession in 2017 however.
2. Fewer people expected to be in work
A smaller than expected economy looks set to mean slower employment growth too. Again only one (Beacon Economic Forecasting) among the 18 forecasters providing data dissents from this position. Taking the average 2016 and 2017 revisions together, 320,000 fewer people are projected to be in work in 2017. Beacon’s increase of just under 100,000 contrasts with a maximum reduction of 570,000 in Goldman Sachs’ figures.
3. Inflation could pass the Bank of England’s 2% target next year
A weaker pound increases the costs of imports – both final and intermediate goods – feeding directly into inflation over the near-term. Just two of the 21 forecasters projecting CPI figures for 2016 and 2017 thought that inflation would be lower over the two years than they did before the referendum. Taking an average across the updated forecasts, inflation is projected to rise to 2.5 per cent in 2017, but the range goes as high as 4 per cent (HSBC).
4. The pay squeeze may return in 2017
After a six-year period in which inflation-adjusted average pay fell, real-terms pay picked up slowly in 2014 and a bit more robustly in 2015 (thanks in no small part to ultra-low inflation). It has fallen back below the pre-crisis trend of 2.2 per cent over the first half of 2016 (despite inflation remaining well below target), and today’s projections suggest that it is set to slow further this year and next.
Taking an average across 21 forecasters, real-terms pay is set to rise by 1 per cent in 2016 (down from a pre-referendum average projection of 1.5 per cent), before falling by 0.1 per cent in 2017 (compared with a previous projection of 1.3 per cent growth). In some forecasts this is driven by expectations for higher inflation; in others it is driven by downward revisions in nominal pay growth; in some both factors combine.
Those who receive part of their income in the form of state support are also likely to face new pressure as a result of higher inflation. The four-year freeze in the value of many working-age benefits will bite significantly harder in a world in which the cost of living is rising more rapidly. For those in work and in receipt of tax benefits, the next few years could bring a double-hit.
5. There is bad news too for the public finances
The government has made it clear that the new economic situation means that the previous Chancellor’s target of surplus in 2020 may no longer be appropriate. Prior to any formal announcement of shifts in spending or in tax and benefit policies, the average view among the independent forecasters is that public sector net borrowing (PSNB) will continue to fall in the coming years, but that it will do so more slowly than they assumed before the referendum.
These forecasts put borrowing roughly £7 billion higher than thought in 2016 and £13 billion up in 2017. By way of context, recall the controversy surrounding the £12 billion reduction in welfare spending announced by the government in the 2015 Summer Budget. Of course, the comparability of those numbers rests on the extent to which the borrowing increases prove to be permanent rather than temporary but, taken together, they imply a cumulative hit of just over £20 billion.
New challenges and old
The one thing we can know for sure is that these forecasts will be wrong, with all of the numbers are likely to change significantly over the coming weeks and months. Forecasting is an imprecise exercise at the best of times: the current heightened uncertainty means that we should take these early responses with a larger dose of salt than usual.
Nevertheless, the consensus appears to point to a slowdown in growth, a squeeze on earnings, falling employment and deterioration in the public finances – with the scale of these setbacks potentially sizeable. Public policy – fiscal and monetary – can help of course, but there is a very real chance that household living standards will once again suffer in the next 12 months or so. Coming so quick on the heels of the protracted fallout from the financial crisis, this could put severe pressure on already stretched household budgets.
Supporting living standards over the coming years will rest in no small part on achieving the right post-Brexit relationship with the rest of the world. But while the economic outlook is much-changed, there is a very familiar feel to many of the challenges – from raising employment, to tackling low pay and achieving the right level of state support. The new Prime Minister has stated that Britain needs to be a country “that works for everyone”. That’s an admirable mission – and one that has become both more important and potentially harder to achieve over the last few weeks.