Brighter economic backdrop strengthens Theresa May's bid for stability

Theresa May calls for general election Theresa May calls for general election
03:19

What a difference a year makes. It was a spring morning on Friday May 13 last year when George Osborne, the former Chancellor, stood beside Christine Lagarde, managing director of the International Monetary Fund as she warned that the outcome of a Brexit vote ranged from “pretty bad” to “very, very bad”.

But if that May morning at the Treasury was unlucky for anyone, it was Lagarde and Osborne.

Just a few months later, Number 11 Downing Street had a new occupant, while the IMF chief became part of an establishment left with egg on its face after predictions of market turbulence and a short-term hit to growth failed to materialise.

George Osborne walks alongside Christine Lagarde at the Treasury in London Credit: AFP

With hindsight, the UK economy’s resilience has been one of the few constants following the Brexit vote. Growth has strengthened against a brighter global backdrop and the world appears to be emerging out of its decade-long funk.

Uncertainty remains. Some economic indicators suggest the UK’s mini-boom is running out of steam. Higher inflation is also eroding real incomes, which could lead to a slowdown in consumer spending.

There are many reasons to be cheerful.

The UK economy is expected to expand by about 0.5pc in the first three months of this year, while the weaker pound has boosted UK exports and helped the UK’s current account deficit - which measures trade as well as overseas income and payments - to narrow significantly.

House prices aren’t booming, but they haven’t collapsed as some had predicted they would.

It was against this backdrop that Theresa May called a snap election that she claimed would “guarantee certainty and stability for the years ahead”.

“Despite predictions of immediate financial and economic danger, since the referendum we have seen consumer confidence remain high, record numbers of jobs, and economic growth that has exceeded all expectations,” she said.

What we’ve seen in the short term is considerable resilience of the British consumerMaurice Obstfeld

Employment is close to a record high, while the unemployment rate has not been lower since the 1970s. The UK economy is in a good place as negotiations with Brussels begin.

As for the IMF, it continued to backtrack on warnings of short-term economic pain on Tuesday as it upgraded its forecasts for UK growth by more than any other major economy.

Growth is now forecast at 2pc this year and 1.5pc in 2018, up from predictions of 1.5pc and 1.4pc respectively just three months ago.

The UK economy is now predicted to grow faster than any other G7 nation this year apart from the US.

Gian Maria Milesi-Ferretti, a deputy director at the Fund, said the upgrade was due to the “resilience of the economy, which surprised us on the upside on account of the strong private consumption”.

However, he highlighted that some of the growth was driven by households running down their savings to fuel consumption.

Official data show the household saving ratio - which measures the amount households have available to save as a share of disposable income - fell to a record low of 3.3pc in the final quarter of 2016.

“The mirror image is a declining saving rate. We do think eventually consumption will adjust. So we expect some slowdown in consumption, some recovery in saving, and hence lower growth going forward.”

Maurice Obstfeld, the IMF’s chief economist, also defended its pre-Brexit vote scenarios, which he claimed were not all doom and gloom.

He said the future of the UK economy would still be shaped by the Brexit deal Britain struck with Brussels. “What we’ve seen [in the short term] is considerable resilience of the British consumer,” he said.

Asked about the impact of Mrs May’s snap election call on its forecasts, Mr Obstfeld insisted that it was up to the British people to decide their own destiny.

But he added: “I think that as a general view more uncertainty is not good. But there was already uncertainty over how the negotiations would go and what its final outlines would be. This may [present] a trade-off between more uncertainty before June 8 for a little less uncertainty later.”

The Prime Minister herself said she came to the conclusion that a snap election was necessary “recently and reluctantly”.

“Since I became prime minister I have said that there should be no election until 2020, but now I have concluded that the only way to guarantee certainty and stability for the years ahead is to hold this election and seek your support for the decisions I must take.”

May says an election is the only way to provide stability May says an election is the only way to provide stability
01:25

Sterling jumps to six-month high

The pound soared to a six-month high against the dollar following her announcement, while UK 10-year borrowing costs nudged down slightly.

The decision was described as a “game changer” by Deutsche Bank, which announced yesterday that it would close out “all our bearish foreign exchange trades”.

In a note to clients, Oliver Harvey, an economist at Deutsche Bank, outlined three reasons why Mrs May’s decision was a smart move: “First, it makes the deadline to deliver a ‘clean’ Brexit without a lengthy transitional arrangement by 2019 far less pressing given that no general election will be due the year after.

We have been structurally bearish on sterling for the last two years but are now changing viewOliver Harvey, Deutsche Bank

"Second, it will dilute the influence of MPs pushing for hard Brexit, strengthening the government’s domestic political position and allowing earlier compromise over key EU demands for a transitional arrangement.

"Third, it strengthens the PM’s overall negotiating stance... which in recent weeks has clearly fallen in line with the European negotiating approach,” he said.

In short, holding a general election now buys time to reach a sensible deal and reduce the “crash risk” of Brexit negotiations.

“We have been structurally bearish on sterling for the past two years but are now changing view,” Mr Harvey said.

The surprise move by Mrs May could also see some traders unwind their short positions in sterling as it becomes a “pain trade” to hold the strengthening currency.

Data published by the Commodity Futures Trading Commission show speculative net sterling short positions stood at 105,901 contracts last week, close to a record high.

One trader said the sudden spike in the value of the pound against the dollar “feels like short positioning on the pair is being reduced in drastic fashion”.

The pound spiked above $1.29 against the greenback on Tuesday. Citi said last month that if it climbed to $1.2735 against the dollar this “could trigger a move to [around] $1.34 to $1.35, because of the significant net short positions.

With the UK now on course for weeks of political campaigning, many economists believe a general election will give the new government a mandate to shape the domestic agenda - though this could involve more tax rises if the UK wants to balance the books amid greater demographic challenges.

If the Conservatives win a bigger majority as expected, Martin Beck, lead economist at Oxford Economics, expects it to “dispense with the more questionable policies contained in the 2015 Tory manifesto”, including the so-called “tax lock”, which bars rises in income tax, VAT and national insurance contributions for the duration of this parliament.

The triple-lock on pensions which guarantees that state pensions will always rise by at least 2.5pc is also likely to go.

“The likely outcome of June’s election could provide helpful fillips to both certainty about the UK’s direction of travel post-Brexit and flexibility in domestic policy-making,” he said.

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