Brexit Looks A Breeze Compared To QE Risks

Goodbye 2016 – and, in the minds of many, “good riddance”. There’s no denying that the UK’s Brexit vote, combined with “The Donald” winning the US election have made this year, for some, an annus horribilis.

The grim drumbeat of on-going terrorists atrocities and, at the other extreme, the passing of an unnervingly large number of much-loved cultural figures, means we can all agree 2016 has had its share of bad news.

What’s clear, though, is that despite numerous predictions to the contrary, the UK economy has held up well over the last year. GDP grew 0.6pc during the quarter following the Brexit referendum in June, according to data released just before Christmas, the same as the three months before.

Quarterly growth of 0.6pc is, ordinarily, wholly unexceptional – translating into an annual rate of 2-2.5pc. But given the onslaught of official pre-referendum warnings that voting Leave would spark an immediate economic slowdown, this latest growth number deserves attention. The International Monetary Fund and the Organization for Economic Co-operation and Development were both wrong. So was the Bank of England and, above all, The Treasury – which predicted “an immediate and profound shock” following a Brexit vote, a claim then Chancellor George Osborne repeatedly described as “fact”.

As an economist, I fully accept how difficult it is to make successful forecasts. We all make honest mistakes. During the febrile referendum campaign, though, some Whitehall economists – no doubt under pressure from their political masters – produced economic forecasts deliberately designed to present the notion of leaving the EU in the worst possible light.

Assumptions were made – some of them ridiculous – that exaggerated possible gains from continued membership, while deliberately understating the benefits of leaving, as this column disclosed at the time. So blatant was the bias that I sincerely believe lasting damage was done to the precious independence of our civil service.

The latest data shows buoyant growth since the referendum, with business investment also up. Consumer spending has remained strong, rising 0.7pc during the third quarter, compared to the same period in 2015. Real household incomes, though, grew at an annual rate of just 0.3pc, their weakest in two years, amid rising inflation – caused in part by dear imports due to the fall of sterling. During the third quarter, as price pressures built, post-inflation household incomes actually fell.

In November, the CPI price index was 1.2pc higher than the same month in 2015 – with inflation still well below the Bank of England’s 2pc target, but sharply up from 0.3pc as recently as April. While a weaker pound explains some of the rise in inflation, higher oil prices are increasingly to blame.

Over the last three months, the price of crude has risen by more than 30pc – from around $42 to $55 a barrel. Given that oil hit a low of $38 back in February, if crude now stays roughly where it is, an oil price rise of some 45pc will feed into next month’s annual price data. That would cause headline inflation measures to spike – putting further downward pressure on real household incomes during the first quarter of next year.

That’s not to say a lower pound hasn’t been important in generating weaker post-inflation income growth. In the aftermath of the Brexit vote, having been bid up strongly on widespread predictions Remain would prevail, sterling initially fell no less than 16pc. Since then, though, the pound has partially recovered, and is now just 9pc down on its pre-referendum level, according to the Bank of England’s real exchange rate index.

Not everything in the UK’s economic garden is rosy – as I’m often quick to point out. A big blot on our data landscape is a quarterly balance of payments deficit that remains uncomfortably high. Britain’s current account deficit widened to £25.5bn during the third quarter, no less than 5.2pc of GDP, up from £22bn during the three months before.

Since then, though, there are strong signs a lower pound is starting to boost the competitiveness of UK goods abroad. In October, goods export rose by £2.1bn to reach £26.8bn – the highest level since the current data series began in 1997, with sales in non-EU nations also jumping to record levels. And in November, UK car production rose 13pc year-on-year, to hit a 17-year high – driven by record sales abroad. The overall trade picture remains weak, though, given the extent to which UK consumers continue “sucking in” imports.

What dangers does the UK economy face in 2017? I’d say that the biggest is the eurozone. Over Christmas, more than eight years on from the banking crisis, we saw the bail-out of another Italian bank – Monte dei Paschi di Siena. This will be “paid for”, of course, with the help of yet more “printed money” – in the form of quantitative easing by the European Central Bank.

Even by the standards of eurozone banks, Italian banks have vast swathes of non-performing loans smouldering on their balance sheets – amounting to over 20pc of the nation’s GDP. The problem, going way beyond the usual culprit of crony capitalism, is that Italy has barely grown since the euro was launched in 1999, locked in a high-currency straitjacket.

The euro is unsustainable – and is continuing to do very real damage not just to Spain and Greece, where youth unemployment is tragically around 50pc, but also to Italy. One of the world’s major economies, Italy already has state debts approaching a massive 135pc of GDP – even before this latest bail-out. Using ECB funny money indirectly to finance yet more Italian government bonds, is unsustainable not just economically, but politically too. That which is unsustainable will, ultimately, not be sustained. With large Italian banks now openly failing, 2017 could be the year when the deep structural incoherence of the eurozone finally comes to the fore.

None of this is to deny that the UK itself isn’t taking big risks on the monetary front. Our money-printing programme – which had ballooned to a £375bn operation, compared to an intended £50bn when it began in 2009 – has since been expanded even more. With the Prime Minister now questioning QE, the Commons Treasury Select Committee agreed in December to conduct an inquiry into its impact on savers and inequality more generally – issues this column has highlighted for many years.

In the US, too, QE – which keeps insolvent banks afloat, while helping governments borrow cheaply – has been used to an extent going way beyond what could be justified in the aftermath of the 2008 financial crisis. Central bank balance sheets have been abused by our political and financial classes – with an emergency measure morphing into a lifestyle choice.

With the new US President due to be inaugurated on 20th January, Donald Trump’s action could clearly have an impact on the UK’s economic prospects during 2017. His rhetoric is certainly rather alarming – not least when it comes to trade. While a US trade war with China is possible, and any such dispute would cause shockwaves across the world, I don’t think it’s likely. Both sides have too much to lose.

No – with the US now raising interest rates, the main danger facing the UK economy in 2017 relates to the on-going use and ultimate withdrawal of QE across the Western world, particularly in the eurozone. Global markets remain extremely fragile – a pack of cards resting on printed money. Compared to the dangers of a QE-unwind, Brexit is a piece of cake.

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