UK Economy Faces Hidden Challenges

Once Britain recovered from the worst of the crippling damage done by the financial crisis, the economy started to tick along at a reasonable pace. Since June 2016, however, when Britain voted to take itself out of the European Union, volatility and political intrigue have returned to the country’s macroeconomic picture.

Britain now faces a whole heap of issues, many of which are tied to Brexit. Inflation is surging, consumer spending is slowing, productivity remains mired in pre-crisis growth levels and uncertainty reigns supreme.

Business Insider got in touch with strategists, analysts and economists from banks, asset managers, and research houses asking them to let them know what they believe is the single biggest issue facing the British economy. The agency has rounded up a handful of the most interesting responses.

 Inflation

Inflation has jumped to its highest level since 2013 in the year following the Brexit vote as the pound plunged in value against the dollar. While it saw a surprise fall from 2.9% to 2.6% in June, the level of price growth for everyday goods and services remains worryingly high, and well above the Bank of England’s 2% target.

Inflation is probably the biggest challenge currently facing the UK economy.  The depreciation of sterling is raising import prices and therefore diminishing consumer purchasing power, while at the same time wage growth is slowing down.  

This weakness in consumer demand, combined with the anticipated slowdown in business investment during the Brexit negotiation period, means that it will be difficult for the UK economy to maintain the level of growth it experienced during 2016.”

 Consumers Feel the Squeeze

One of the knock-on impacts of inflation’s surge in the last year is that British consumers are feeling the squeeze as prices rise, but wages do not. In the second quarter of this year, Visa’s widely watched index of consumer spending recorded the weakest quarter for expenditure since the third quarter of 2013.

The immediate worry is for the UK consumer. The squeeze on spending power from weak wage growth and rising prices has led households to borrow more through credit cards and personal loans.

 Rate Dilemma

Brexit has speared the Bank of England’s Monetary Policy Committee on the horns of a dilemma. The central bank must balance growing inflation–which usually calls for an interest rate hike–with the slowdown in the economy and dwindling consumer spending, which requires rates to fall. On the one hand, consumer credit is rising sharply, and in order to tackle this, the Bank of England would like to raise rates just to show that they go up as well as down.

“After a decade of falling interest rates, eight million Britons have now never seen an interest rate rise in their adult life. However economic growth is weak and looks to be slowing, and any rise in interest rates is likely to slow down consumer spending, which is a key driver of returns.

 Productivity

Productivity is a huge challenge for the UK, and one that is not widely discussed outside economic circles. Brits may work long hours but it’s not generating growth. Arguably the biggest challenge for the UK at the moment is productivity. According to the latest figures, UK productivity (as measured by output per hour) contracted by 0.5% in the first quarter of 2017. The latest drop more than reverses the modest gains made in 2016 and leaves the level of UK productivity at its lowest since before the 2008 financial crisis.

Productivity needs to rise if the UK is going to have any chance of sustaining reasonable economic growth.

 Brexit & Pessimism

Brexit is undeniably one of the biggest events in recent British history. Over the course of the next few years the UK’s entire relationship with the rest of Europe is likely to be totally reshaped. How policymakers deal with the challenges of Brexit will shape UK economic success for decades to come. The Brits will continue to expect the UK to slow relative to other developed economies.

Bank of England Governor Mark Carney and Chancellor Philip Hammond are two major figures accused of being deliberately negative about the economy in the time since the referendum. Proponents of Brexit believe that the UK should have an outward looking, expansionary vision for its economic life after the EU, striking trade deals around the world and internationalizing commerce.

The biggest threat to the UK economy’s prospects is undue pessimism about those prospects among policymakers, forecasters and commentators.

 Uncertainty & Poor Planning

No-one, not even David Davis and Michel Barnier, the Brexit secretaries, has a definitive vision of how Brexit talks will play out over the next 18 months. While both sides have negotiating positions and aims, what actually happens is anybody’s guess. Among the questions that must be answered is whether or not Britain is definitively leaving the European Single Market. The lack of answers to this kind of question makes it difficult for businesses to plan ahead.

A transitional trade deal may well soften the blow of Brexit itself, however, it also risks simply extending business horizons (short-term until Brexit; medium-term until the end of transitional trade deal). “Rather than offering the clarity most are pining after, opaque Brexit negotiations may simply further extend current delays to decision-making, impacting the even more important long-term.