What can we expect in 2018? | KPMG | UK

What can we expect in 2018?

What can we expect in 2018?

Politicians rule, Bitcoin under pressure, and a new central banks order.

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Chief Economist

KPMG in the UK

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 What can we expect in 2018? - Man with binoculars

As 2017 draws to a close, it will be remembered as a positive year for the world economy, with growth momentum accelerating, asset prices on the rise, and scant volatility. Even in the UK, worst case scenarios such as an abrupt early departure from the EU, have been averted (for now at least) – and negotiations on the transitional and final relationships between the EU and the UK are moving ahead.

Nonetheless, 2017 also marked the UK’s decoupling from the overall positive trend for the world economy. Higher inflation, Brexit-related uncertainty and poor productivity performance have all taken their toll on the UK economy: GDP growth is expected to moderate to 1.5% this year as consumers’ income is squeezed and spending is less forthcoming. We could see much the same GDP growth in 2018.

Assuming that there are no further major falls in sterling, the inflationary impact from earlier declines, through a rise in the cost of imports, should gradually dissipate. Alas, that is not the only thing on the Bank of England’s mind. Unemployment could slip to 4.2% or even slightly lower next year, which is towards the bottom of the 4% to 4.75% range that the Bank of England now considers as the equilibrium unemployment rate. A tight labour market could put pressure on wages and inflation – although we do not expect wages to rise by more than 2.7% on average next year and anticipate inflation will moderate to 2.3% by December 2018, with an average of 2.6% for the year as a whole. Given current uncertainties, the Bank of England may raise rates only once in 2018 to 0.75%, with an additional one to two further increases later on.

Just as in 2017, next year presents more risks on the downside than prospects on the upside. Once again, it is political developments that could pose some of the biggest challenges for the world economy. To take just a few examples: a NAFTA negotiation collapse could affect other trade deals; the results of the Italian elections and an unstable German government may weaken the EU; and elections in Mexico and Brazil could create a less favourable business agenda in Latin America. Political risks are particularly heightened in the UK, with a potentially fragile government and an arduous negotiation process to undertake with the EU.

Record low base rates over the past decade, and an unprecedented deployment of quantitative easing by the major central banks since the Great Recession, have created side effects in the form of asset price distortions and potential bubbles. The first that comes to mind, and the first which might pop – is Bitcoin, which as of 18 December was up by almost 1800% since the start of the year. Hopefully, this does not, however, signal the end of cryptocurrencies. If ways can be found to make them a more reliable store of value and easier to spend, they could trigger significant advances in trade – provided they become more secure, as Blockchain technology increases transparency.

More traditional asset classes, such as bonds and equities, show signs of high valuations across many countries, but the very gradual unwinding of central banks’ loose policies could at least delay a broader market correction.

Despite the expected slow pace, the direction is quite clear: central banks are looking to put their houses in order after more than a decade of largesse. The pursuit of monetary policy normalisation is the third potentially important trend for next year. If rising inflation pushes central banks to tighten more aggressively, volatility may resume.

There are other potential risks which could push the world economy into a more difficult path. Again just like 2017, however, next year could positively surprise us with a smoother monetary transition and more encouraging political outcomes. Let’s hope that is the case.

Happy 2018.

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