© Paul Hollingsworth
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We are very upbeat about the prospects for the UK economy, however, in the near term the activity indicators have softened a bit. Therefore, the Q3 GDP number may be a little bit weaker than Q2.We might see growth around 0.5%, at least currently that is where the PMI numbers are pointing to. Nevertheless, we believe that growth will pick up for the rest of the year.
For this year as a whole, we forecast annual growth in GDP of 2.7%, whilst there are few uncertainties over the next year, which means we might see growth to remain a little bit weaker. In particular, things like build up to referendum of the UK's membership of the European Union and the fiscal squeeze tightening. Hence, given all of the above, we have penciled in 2.5% growth for 2016. I think that is still above the consensus, therefore, we are fairly optimistic. Moreover, for 2017, we expect growth of 3%, which again is quite stronger than other economists' expect to see.
Part of the reason for such a positive outlook is that we believe there is much more spare capacity in the economy, than many other analysts think. Hence, we believe there is plenty of scope for the UK to grow above the trend rate for a number of years without kind of stoking inflationary pressures.
Sharp falls in petrol and diesel pulled UK inflation back down to 0% last month as tumbling crude oil prices trickled down to households. Analysts mention that the lack of inflation would continue to boost consumer spending, the main driver of the economic growth. However, there are also talks about the damaging period of deflation for growth. What is more harmful for UK economy? Do you foresee a serious thread of deflation in the long run?
We expect to see a negative inflation over the next couple of months, and that is primarily down due to mentioned falls in energy prices that we have seen. However, in terms of a prolonged period of deflation, the type that we should be more worried about, we do not see it coming in the near future.
If you look at households' inflation expectations – they have held up quite well considering inflation has fallen so far. Hence, it does not suggest that consumers are going to start delay spending in anticipation of lower prices. Indeed, the deflation that we are going to see over the next few months is of a good sort, and will provide a boost to households real spending, rather than be something to worry about.
Some of the BoE monetary policy committee members are shift on a more hawkish stance. In particular, Ian McCafferty, who commented that return of real wage rises this year and the prospect of higher oil prices would serve as a reason. Also, The UK is recovering in strength and is unlikely to be knocked off course by volatile global markets. Do you believe that there are enough bases for the hike at the moment? When do you expect the BoE to act?
We do not think that there is enough to justify a hike right at the current moment. For one thing, although we have seen earnings growth pick up, productivity has started to rise as well, which should mean that firms unit wage costs do not increase too fast. This also signals that inflationary pressures as a whole will not build up rapidly over the coming months.
There is a lot of uncertainty at the moment, and note that the MPC has never raised rates when inflation has been more than 1 percentage point away from its target. Hence, looking at around the turn of the year, for example at the MPC meeting in February, the data then should show that inflation is still around zero. Therefore, I think that it will be highly unlikely that the BoE would raise interest rates in such a situation. However, as the economy continues to recover, and the previous sharp falls in energy prices drop out of the annual comparison, the MPC are likely to tread closer to raising rates around Q2 2016. The bigger picture, though, is that interest rates will be increased very slowly thereafter.
What other major factors will influence the Sterling till the end of 2015?
I think the big movement could be Sterling versus the Dollar. We continue to think that the markets are underestimating the extent to which interest rates will have to rise in the United States, and that is partly because we think that wage growth is going to start to build up much more rapidly without the corresponding increase in productivity.
I guess there is a host of other uncertainties going on, including concerns over China and Greece. We have got the spending review and the autumn statement coming up in the next couple of months as well, which might have an influence. In terms of the UK monetary policy, we think that the markets are not too far wrong at the moment, in regards of pricing an interest rate increase well in the next year rather than around a turn of the year.
What are your forecasts for EUR/GBP and GBP/USD for the year end?
We expect the GBP/USD pair to trade at 1.5 and we foresee the EUR/GBP at 1.36 by the year end.