Alarm Bells Start Ringing for U.K. Economy
(Bloomberg View) -- Having long been considered one of the most stable democracies in the world, Britain will hold a new general election on June 8 -- barely two years after the last. However, with the Conservative Party on course for securing a comfortable majority, political uncertainty may not be the biggest risk facing the U.K. A weakening economy could well pose a bigger threat.
Ever since the U.K. voted to leave the European Union in June, economists have predicted that Brexit would inevitably weigh on growth. So far, the U.K. economy has defied the gloom, expanding by 1.8 percent in 2016. The main reason behind this resilience has been consumption, as shoppers continued to take to the high streets, driving household spending up by 2.8 percent for the year.
There are signs, however, that consumers will find it increasingly hard to fuel the recovery on their own. A combination of slowing wages and rising inflation has begun to squeeze their living standards. And since investors, exporters and the government are unlikely to come to the rescue, the U.K. may be about to find out that its choice on Europe will indeed a carry a cost.
The root of the problem lies in the sharp depreciation of sterling that followed last year's Brexit referendum. Devaluation has pushed up the price of imports, driving inflation to 2.3 percent in March. Furthermore, this sharp increase isn't over: The Bank of England expects price pressures to hit 2.7 percent at the beginning of next year, but some private forecasters think it will go above 3 percent.
Rising inflation needn't bother consumers so long as wage increases keep pace. This isn't happening. Regular weekly earnings in the three months to February were 2.2 percent higher than in the same period a year ago, down from 2.4 percent in January. So inflation-adjusted pay is nearly stagnant -- and incapable of sustaining a consumption boom.
In theory, shoppers could draw down their bank accounts or borrow more as they wait for salaries to pick up again. This is exactly what has occurred, so far. At the end of last year the saving rate fell to 3.3 percent, the lowest since records began. Consumer credit is also rising, touching an annual rate of 10.9 percent in November, the fastest since 2005. However, this profligacy cannot go on for ever: The Bank of England has already warned about the risks of a new lending binge and may act to rein it back.
Might exporters take up the running? You'd expect the sharp depreciation of sterling to make British goods and services more competitive, helping to drive growth. There's little sign of this yet. True, the U.K.'s external deficit narrowed sharply at the end of last year. But this was due to a sudden increase in gold bought in China from the London Bullion Market. The latest official data show that manufacturing is struggling.
The biggest question mark relates to business investment. Fears that companies would stop investing until Britain and the EU settled on a deal were definitely overblown. Even so, it's hard to see investment accelerating before it's clear what kind of access to the EU market U.K. companies will enjoy.
What about the public sector? Were the U.K. to fall into a full-blown recession, the government would probably use tax cuts and public spending to help the economy. However, it's a lot less clear that this would happen in case of a mild slowdown. So far, Philip Hammond, chancellor of the exchequer, has taken a prudent approach to the public finances and, barring any major surprises in the forthcoming general election, this seems likely to continue.
The U.K. economy has taken the referendum and its aftermath in stride -- up to now. There's a clear risk, however, that the economy deteriorates just as the government begins to negotiate with the EU on the terms of its departure. The perils of Brexit have barely begun.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Ferdinando Giugliano writes columns and editorials on European economics for Bloomberg View. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times.
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