Publication - A MONIAC (not manic) Economy - speech by Kristin Forbes
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The UK Economy Relative to the Forecast
It is easy to poke fun at economists. I have a large repertoire of jokes about how many economists it takes to change a lightbulb, or how an economist opens a can when shipwrecked on a deserted island. Most recently, the jokes have shifted to how many economists it takes to make a forecast. And there is certainly fodder for criticism.
The vast majority of economists and forecasters expected the UK economy to slow immediately after the UK voted to leave the European Union, with some even predicting an outright recession. Most put substantial weight on the evidence that growth, and especially investment, tends to slow sharply in the face of heightened uncertainty.2 I was on the more optimistic end of the forecasters, but I still expected to see at least some softening.
But this slowdown has not occurred - and it has now been over 7 months since the June vote. GDP growth has been remarkably stable at 0.6% for three quarters in a row - the last two after the referendum. This is not only faster than the average growth rate in 2015, but probably above the economy’s long-term potential growth rate. Growth may still slow as higher inflation reduces real incomes, or if negative supply effects related to the UK’s departure from the European Union build over time. Signs of such a slowdown starting soon, however, are as yet few and far between.3
What is most striking is how well forecasts for the six months after the vote have performed for most real variables - that is - forecasts made before the referendum based on a Remain vote. To make this point, Figure 2 compares the most recent data for the fourth quarter of 2016 with the MPC’s best collective forecast as made just before the referendum (in the May 2016 Inflation Report). This forecast followed the usual convention of assuming a continuation of government policy, and therefore a vote to remain.
Starting with demand and its components, GDP growth in Q4 was 0.3pp stronger than the 1.9% (year-on-year) we forecast in May. This outperformance is largely due to consumption - which is expected to be 0.5pp stronger in Q4 than the 2.4% predicted in May.4 The one demand component which is predicted to be substantially weaker than forecast is investment, which is on track for only 1.6% growth in Q4, well below the May forecast of 4.9%.
Moving to the labour market, all measures are close to our May forecast, and most a touch stronger. The unemployment rate is currently 4.8% (lower than the 5.0% predicted in May), slack is lower (this does not incorporate an adjustment to the equilibrium unemployment rate in the latest IR - which I’ll explain in more detail soon) - and total weekly hours higher. The only data that is a bit weaker than predicted in May is wage growth. Whole economy total pay growth was 2.8% in Q4, somewhat below the 3.1% forecast, although private sector regular pay growth (which is a more informative measure of underlying pay pressure, but not forecast by the MPC) reached 3.0% in Q4.
Finally, moving to asset prices and the nominal data, Bank Rate, the yield curve, and most borrowing costs are lower than expected in May - which is not surprising given the Bank of England’s substantial easing measures last summer. House prices have increased a bit less than expected (by 5.5% year-over-year, as compared to 6.7% forecast in May). But by far the biggest change from our pre-Brexit forecast is sterling - which is now 11% weaker than at the time of the May IR (and 18% weaker than its recent peak in November 2015).5 This depreciation has driven up many nominal variables - such as import prices and inflation expectations - and contributed to CPI inflation 0.3pp higher over Q4 than forecast in May. Inflation going forward is expected to increase even faster. These nominal effects of sterling’s depreciation, however, have largely been in-line with the standard effects from a depreciation of that magnitude.
The bottom line: the real economy, including the labour market, have performed largely as forecast last spring. Most economic measures (except investment) have matched or slightly outperformed our May expectations based on a Remain vote. The UK economy appears to have been largely resilient to Brexit uncertainty. The main exception is sterling and the nominal data - which indicate sharply higher inflation than expected last spring. This leads to an obvious question…
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