What 2017 may bring for the economy: return, reassess and retreat

What 2017 may bring for the economy

We take stock of the past 12 months and get ready for the year ahead.

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Chief Economist

KPMG in the UK

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It is that time when we take stock of the past 12 months and get ready for the year ahead. Looking back, it is striking how different the world seemed this time last year, when our key themes for 2016 were:  

  1. Investors will lose enthusiasm for emerging markets currencies and debt 
  2. Higher oil prices in the second half of the year will see higher inflation and rates  
  3. Security concerns will see free movement of people come under strain

While some of these themes were in the right direction, they failed to anticipate two of the major events in 2016: the Brexit vote in the UK and Trump’s US presidential victory. Both were good reminders how political events can stir the economy and business environment well beyond the natural course of events observed by the economic cycle. 

In the UK, the result of the EU referendum vote has so far had less impact on the real economy than originally feared. The largest impact this year has been on the exchange rate and that is slowly being transmitted into higher prices. 

With so much yet to be decided in regards to the UK’s future trading relationships with the EU and beyond, businesses are expected to delay some of their investment decisions. Our forecast is therefore for investment to fall slightly next year (see table below). Consumers have so far shrugged off the uncertainties caused by Brexit, with consumer spending remaining strong until now. Yet, as rising inflation starts to hit households in the pocket next year, and employers become more cautious on hiring, consumers are expected to become more careful.  

Overall, we expect UK GDP growth to moderate to 1.2% in 2017, with inflation rising above the Bank of England’s target of 2%. We think unemployment is likely to remain relatively low, despite the weaker economic environment, as the fall in sterling and uncertainties over Brexit make the UK less attractive for foreign workers, and employers seek to hold on to staff in anticipation of downward pressure on migration and potential difficulties in filling vacancies. Low unemployment should continue to provide support to house prices as well as consumer spending.

Looking beyond the main UK numbers, the following themes for 2017 may emerge:

Inflation returns

A weaker sterling has already triggered a spurt of inflationary pressure in the UK, but other factors beyond the UK borders are also at play. Higher oil prices seem to be here to stay, at least during the first half of 2017, and assuming that OPEC’s recently announced cuts in production hold. Though US shale oil production will provide a ceiling to any rise, and our current expectations are for Brent oil price to rise to just under US$60 a barrel next year, up from US$56 today. The new US administration is expected to put its foot on the gas when it comes to fiscal expansion and push for increased infrastructure spending. And with US economic growth expectations on the up, so is the outlook for inflation. This is likely to see a more pronounced rise in US Fed rates next year, and is also seeing a rise in bond yields more broadly, a phenomenon not unique to the US.  

While higher inflation will put pressure on household spending, it may also provide some breathing space for banks, pension funds and savers, and move the developed world one step closer to more normal levels of interest rates.

Consumers reassess

Higher inflation and greater uncertainty could see UK consumers pause and re-evaluate their needs and spending habits. This time, consumers’ soul-searching may extend beyond questioning affordability, and into areas they see as important more generally. We could see consumers voting with their purse as an extension to their ballot vote, as they seek to keep their voice heard. Businesses may need to become more sensitive to issues that matter to their customers and how they are perceived, from paying taxes, to corporate pay gap and consumer protection.

Globalisation in retreat

Probably the biggest economic shift we are currently experiencing is the realisation that globalisation as we had it no longer works. The big question mark for 2017, and probably beyond, is whether an agreeable solution can be arrived at, which marries the big benefits of globalisation with a more compassionate transition that shares the gains more equally.  

There is a lot at stake. The impact on the world economy from less trade and reduced flows of people and ideas could be significant. Some businesses, such as international transport and logistic companies and those with highly integrated supply chains, could be particularly exposed, but the impact is likely to reach far beyond those all the way back to consumers, restricting choice and raising prices.

Of course, 2016 has provided us a good lesson that none of the above could ultimately become key. But what we do know is that whatever happens, 2017 is panning out to be very interesting.

So long 2016.

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