Home truths

Worries about Britain’s exit from the European Union will hit growth in 2017

Callum Williams

Britain

Britain will still be in the European Union at the end of 2017, but the prospect of breaking from its biggest trading partner will crimp economic growth. The latest estimates from the Bank of England suggest that the economy will expand by just 1.4% in 2017, down from the 2.3% it expected the month before the vote in June 2016. (The Economist Intelligence Unit expects GDP to grow by 0.6%.) Britons’ pay-packets, already worth 4% less for full-timers than before 2008, may get lighter still, as a weak pound drives up inflation.

Consumer spending is the engine of Britain’s ­econ­omy, accounting for more than 60% of GDP. In the months following the referendum, retail sales were healthy; new-car registrations also held up well. This picture will not change dramatically in 2017. Some people may be more reluctant to open their wallets if there are worrying headlines about the Brexit negotiations. But most British voters appeared to want Brexit, so in 2017 they should be happy shoppers.

Most economists instead expect that the downturn will be caused largely by a drop in investment spending. No one knows what Britain’s future trading relationship with the EU will look like. Carmakers, for instance, worry that any vehicles they manufacture in Britain may soon be subject to a 10% tariff to enter the EU. Banks fret that they will lose the ability to offer their services to EU-based customers. With such uncertainty, businesspeople will hold back from expanding their operations. The evidence suggests that since the referendum investment spending has indeed slumped. 

This hesitancy will have an effect on jobs, too. Since the vote, the number of advertised low-paid and contract positions has grown, as employers seek to plug gaps without committing to permanent hires. The Bank of England’s estimates suggest that by the third quarter of 2017 unemployment will be 0.5 percentage points higher than it would otherwise have been.

Never fear, say the Brexiteers. With the pound having lost more than 15% of its value since the referendum, British exports will soar, they insist. Recent surveys of manufacturing firms have suggested that foreign buyers are showing more interest in British-made goods. Yet there will be no export boom in 2017. A high proportion of Britain’s exports are made up of imports: carmakers, for instance, buy in gadgets from abroad to put on the dashboard. Moreover, British exports compete mainly on “non-price” factors, such as product quality, which makes them insensitive to currency fluctuations. The historical evidence is not encouraging: in 2008-09 sterling fell by a similar amount, but net ­exports barely ­improved.

The British economy will rely on the Treasury and the Bank of England to keep growth in positive territory. Since the vote, the bank has cut the base rate of interest from 0.5% to 0.25%, and it has devised “macro­prudential” tools to ensure that lower rates are passed on to the real economy. The bank will not put interest rates into negative territory in 2017, given the risk that would present to financial stability. But there is little chance of an interest-rate rise, as would have been highly likely had there been a vote to Remain.

With the bank’s hands tied, the government must step in. Philip Hammond, the chancellor, has soft­ened the fiscal stance of his predecessor, which will help growth a bit. But his room for manoeuvre is constrained. As the economy slows, he will worry that tax revenues will suffer. Britain’s budget deficit is about 4% of GDP; Mr Hammond cannot let it rise by much.

No recession, no worries?

If Britain avoids a recession in 2017, some comment­ators will argue that the worries surrounding Brexit were overblown. Such reasoning is confused. Efforts by the central bank and the government to support growth are not costless: ultra-loose monetary policy damages pension funds and the extra government debt must eventually be repaid. More important, most pre-referendum forecasts focused on what would happen in the event of Brexit—which is still years away. The British economy will not crumble in 2017; but that does not mean that a vote for Brexit was a good idea.