Economics 2017: Inflation to kick in; and concerns over spending

The fallout from sterling’s drop will be pressure on the purses of UK consumers, warns Lloyds Bank Commercial Banking head of economics Adam Chester (pictured), but tourism and exports could benefit 

Photos © Joel Chant - www.joelchant.com UNP- 34198 - Lloyds banking Group portraits, 10 Gresham St London

 

INEVITABLY, our negotiations to leave the EU will dominate the domestic agenda during 2017.

Although the upcoming Supreme Court ruling could delay things, Article 50 looks set to be triggered by the end of March.

The government has said it will provide more clarity in the new year, but the prospect of meaningful progress in the negotiations is likely to be hindered by next year’s European political timetable, with those countries facing elections unlikely to be in a mood to compromise.

Until there is much greater clarity surrounding our EU exit, forecasting the UK’s medium-term outlook is tricky.

Still, we can be reasonably confident that a number of developments currently playing out will have a significant impact next year, not least a sharp rise in inflation.

CPI to tick up

Oil prices are on the rise again, but the big impact on UK inflation will come from the drop in the pound.

Although it has recovered some of its earlier losses, the UK currency has still fallen over 11% since June and by 17% since last year’s high.

So far, this has yet to significantly hit retail prices, but by early summer, consumer price inflation is likely to be back above 2% and headed towards 3% by the end of the year.

Typically, a rise in inflation of this size might be expected to prompt the Bank of England to raise interest rates, but it is only likely to do so if the rise in headline inflation starts to show up in a sustained rise in inflation expectations and wages.

We doubt this will be the case next year and we expect the Bank rate to remain unchanged at 0.25% all year, though there are clear risks further out.

So what about the growth outlook?

Softening of job market

Over the coming year there is a good chance the economy will soften. The rise in import prices and inflation looks set to squeeze household pay and corporate profits.

There are also tentative signs that the labour market has turned. Rising inflation and some easing in jobs growth could see household spending slow sharply, while there is a risk that the related uncertainty starts to weigh more heavily on capital spending.

But there also upside risks. The coming year should see a pronounced re-balancing as exporters and tourism-related sectors benefit from the fall in pound, while price pressures may encourage importers to source from domestic suppliers.

Coupled with a sharp improvement in foreign currency earnings, that should narrow the UK’s balance of payments deficit.

Still, given the huge uncertainties, these forecasts should be treated with caution.

The Brexit negotiations, the implications of Donald Trump’s presidency and the European elections still leave plenty of scope for volatility.

Adam Chester is Lloyds Bank Commercial Banking’s head of economics 

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