Forecasts, Fears and Foibles in 2016

Growth …
We expect the UK economy to grow by around 2.5% in 2016 following a similar level of growth in the prior year. Output growth will be determined by service sector activity with a slightly better contribution from construction and manufacturing.

Household consumption with continue to drive the recovery with a more significant contribution from investment. 2016 will continue the years of the LILIES with low inflation, low interest rates and an earnings surge pushing household spending, retail sales, car sales and housing transactions.

Investment will also improve in 2016. Bear in mind almost two thirds of investment is property related (housing and commercial real estate). There should be no real fears for output growth as a result of the post recession, investment slow down. The fixed asset capital stock (plant and machinery) has returned to pre recession levels, with no limits to expansion as the result.

Government expenditure will remain subdued. Export growth may increase as world markets recover. Our models continue to reflect a significant level of import dependency for any export expansion. Hence, there will be no re balancing of domestic demand or total final expenditure as a result.

We expect the trade in goods deficit in 2015 to be £124.2 billion flattered by a £3 billion oil price effect. In 2016, The trade in goods deficit will rise to over £127 billion off set in part by a £93 billion plus surplus on services. The overall trade in goods and services deficit at less than 2% of GDP will not be a cause for concern. The current account deficit is set to moderate as overseas investment returns improve. This should allay fears of a balance of payments constraint to growth over the medium term.

Inflation …
Service sector inflation will close the year end 2015 at around 2.5%. Goods inflation has been flattered by low oil, energy, commodity and food prices prices with an average rate of -2% in the final quarter of the year.

By the end of 2016 most analysts now expect inflation to be around 1% to 1.5%. A fair assumption, assuming no radical reversal of Saudi Policy on oil prices. Were that to happen, the inflation outlook could change quite dramatically as prices firm in commodities and food.

Employment and Earnings …
Employment growth will continue with current levels for vacancies and claimant count now at pre recession levels. Earnings growth will continue as recruitment difficulties in construction and the service sector increase.

Borrowing Figures …
Government borrowing figures will improve as the economy continues to grow. Low inflation is creating a fiscal drag on VAT receipts despite strong retail sales volumes. The OBR targets over the next two years may be a challenge as a result but the official targets are broadly within reach.

Interest Rates …
The Fed has made the first move in the escape from Planet ZIRP. We expect the MPC to follow in less than six months with March or April favourite. By the end of the year rates will be around 1% assuming no radical change in the inflation outlook.

[Planet ZIRP was always assumed to be an emergency stop over and not a permanent settlement. Interest rates at the lower bound and beyond, mis price capital, distort the yield curve, lead to a misallocation of resources, penalise savers, pressure returns within pension funds and generate asset bubbles in gilts, bonds and property prices. Low cost of capital can lead to over investment in oil and commodity prices,  resultant lower prices exacerbating the deflationary environment. Lower rates do not help and negative rates will impair not improve the banking system.  Deposits are withdrawn to avoid punitive charges and the bank asset base and lending capacity shrinks as a result.]

Brexit …
Uncertainty in the run up to the Brexit vote will create a level of investment uncertainty particularly in areas of international syndicated manufacturing i.e. motor, marine and aerospace. Areas in Eastern Europe enjoying strong growth including the Czech Republic, Romania and Poland create attractive alternative investment opportunities for access to broader European markets. We expect the UK to remain "in" post the referendum. The block votes from Germany, China, USA and Japan to have significance in the final count.

World Growth …
World growth is expected to be around 3.5% in the year ahead. Strong growth in India, China, USA and the UK with a developing recovery in Europe will fuel growth.

Oil and commodity based economies have been badly hit. Problems in Venezuela, Brazil, Russia, the Ukraine particularly marked. The slow down is also impacting on the fortunes of Saudi Arabia and Nigeria as oil revenue dependency is significantly hampered.

We expect oil prices to bounce back to $60 Brent Crude basis through 2016 as OPEC begins to react to the reality of US production and domestic self sufficiency.

Should we worry about China …
China is the second largest economy in the world, with a population on 1.3 billion struggling to get into the world top eighty in terms of GDP per capita. Per capita wealth equality with the USA would deliver a Chinese economy valued at $40 trillion, that’s four times the current level, probably doubling world GDP values in the process to around $150 trillion.

Chinese growth may slow to 6.5% as the economy moves to service sector, household consumption based growth. The continued demand for energy and commodity resources will be maintained. With international capital reserves of $3.5 trillion dollars, we should not worry too much about China over the short to medium term.

Things not to worry About …
What colour are the eyes of a Yeti, Equilibrium Real Interest Rates, The Meandering NAIRU, The Output gap, The Capacity Gap, Productivity, Household Mortgage Debt, The Vagaries of Sterling, the elusive J curve, the departure from Planet ZIRP and the timely death of QE.

Things to worry about …
The ease with which the government introduced the Apprenticeship Levy, the Living Wage and the Buy to Let Clamp Down without adequate consultation and deliberation. The challenge to asset prices, particularly bond prices as interest rates are set to rise.

Possibly … the developing trade deficit and the evident current account deficit. Labour Market over heating Missing out on regular updates from The Saturday Economist.

For a full set of forecasts, check out our latest economic Outlook for January 2016 and join the mailing list for the Saturday Economist Weekly Updates. TheSaturday Economist, We always keep you in the picture!

Our What the Papers Say, Twitter morning review will continue in 2016! Follow @jkaonline

We wish you all a Happy New Year. Have a great 2016.

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