The economic outlook is not necessarily less uncertain this year. Coronavirus has been causing us headaches, as we spend time considering implication for our forecasts, not least around interest rates.
Last year, there was a lot of Brexit noise in the GDP numbers, we should see less of this in 2020. But the new normal is lower growth rates compared to those before the Financial Crisis. We’re expecting GDP growth to come in at a similar annual rate this year compared to 2019, but the coronavirus puts this forecast at risk and we are currently reviewing our numbers.
We’re also seeing lower productivity growth, which hasn’t returned to levels seen pre-crisis. While that means we’re seeing stronger employment numbers, this means that for a given growth rate the bank might be more worried about inflation risks in the future.
We are seeing a very low unemployment rate by historical standards and alongside this pay growth is robust. These are factors that justify the BoE continuing to contemplate when and if higher interest rates might be justified at some point.
All of this means the Bank of England (BoE) has a real dilemma: which signal should they listen to when considering changes in interest rates? Should they respond to risks from continuing Brexit uncertainties (and the coronavirus) to the near term growth outlook. Or is the threat of inflation ahead from the tight labour markets more significant.
Overall, “lower for longer” feels like the new norm for interest rates. It’s also going to be a brave BoE Governor who decides to raise or hold interest rates in the face of significant downside risks to economic growth in the very near term.
House price growth has been moderating over the last year. More people in employment has helped to back-stop demand somewhat. However, tax changes and Brexit uncertainty have all had a role to play in moderating price growth. Activity metrics are still weak, and mortgage approvals still haven’t returned to the levels we saw before the Brexit referendum. However, there has been a lot of post-election activity, with more political certainty driving a recovery. Positive activity surveys in housing and the broader economy have reduced near term talk of a BoE rate cut.
With Brexit trade deal talks rolling on through this year, the market is still faces some ongoing uncertainty.
Either a Canada-style deal or a bare-bones Australian deal would both imply a step up in trade frictions compared to current arrangements. But an Australian arrangement would be a very material step up in trade barriers. We’re expecting the negotiations to take a salami-style approach, with individual deals by sector. Either way, the timings are tight and it will be a case of doing what is possible in nine months.
There’s going to be a big deadline in the summer when the final date to agree an extension to the transition period comes through. That may create a bit of uncertainty for the pound in the middle of the year, which has largely been driven by Brexit uncertainty. However, we still expect the pound to continue to rise against the dollar over the medium term.
Regardless of the Brexit process this year, we should also remember the warning from the Swiss: You never stop negotiating with the EU.
Coronavirus is the new risk we didn’t expect this year. We still don’t know how far it will spread or what impact it will have on the global economy. It’s likely that Chinese GDP will fall this quarter, but we will also likely have a sharp recovery. When this happens and how large the bounce is remain to be seen.
Globally, there is also growing disruption outside of China. We’re hearing stories of car manufacturers moving parts in suitcases on planes to prevent production shutdowns. American manufacturers are also seeing an impact on supplies of rare earth minerals. Only time will tell what the economic impact is going to be as we see how far the virus spreads beyond China.
