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UK’s fragile new coalition further muddies outlook for economy

LiveMint logoLiveMint 10-06-2017 Jill Ward

London: Of all the things the UK economy needs, more uncertainty isn’t one of them.

Prime Minister Theresa May’s loss of her majority in Parliament after an election gamble has muddied the outlook for oncoming Brexit negotiations and the economy. After a campaign largely devoid of economic arguments, the new government faces a slew of policy challenges and threats to the growth outlook on top of disruptive divorce talks with its biggest trading partner.

While May moved to form a government quickly, crafting an alliance with Northern Ireland’s Democratic Unionist Party, the result leaves questions over her leadership and another election can’t be ruled out. David Page at AXA Investment Managers described the arrangement as “fragile.”

The shock vote result comes against a backdrop of accelerating inflation, which is already weighing on consumer spending and forecast to wipe out wage gains this year. Economic growth slowed to 0.2% in the first quarter, and the National Institute of Economic and Social Research estimates it hasn’t picked up so far this quarter.

“The economy is going to continue to grow at sub-par levels,” Jagjit Chadha, director of NIESR, said on Bloomberg Television. “We haven’t had any growth in real wages, we haven’t had any growth in productivity in 10 years, and the anxiety that’s causing households is what we’re seeing reflected in the vote.”

In its response, the Confederation of British Industry called on the government to refocus on supporting growth. It must “fix the foundations of the U.K. economy and our productivity problem,” said director-general Carolyn Fairbairn.

Economists in Bloomberg’s most recent survey forecast expansion of 1.7% this year and 1.4% in 2018, weaker than the projections from the Bank of England. The central bank will offer a fresh assessment of the economy alongside its next policy decision on Thursday in what will be its first scheduled remarks since the election.

“Given there are a number of other headwinds -- not least uncertainty about how Brexit is going to be affected by all this, but also the impact of higher inflation -- it’s quite likely we do see some negative impact on growth,” said Paul Hollingsworth, an economist at Capital Economics. “An alliance with the DUP doesn’t condemn the U.K. to economic disaster, but it’s certainly another headwind, so it’s not great timing.”

Surprises

Martin Beck, an economist at Oxford Economics, said a coalition may not be viable over the long term, though one reason for optimism is that the economy has overcome election surprises before.

“There is no guarantee that a second election would be any more conclusive,” Beck said. “The prospect of a prolonged period of domestic political uncertainty risks weighing on economic activity, although the performance of the economy following the EU referendum suggests that the threat from this source shouldn’t be overblown.”

S&P Global Ratings said the outcome of the election should have no immediate impact on the ratings on the UK. Its current assessments “already take into account a less predictable policy framework” since the Brexit referendum, it said. Moody’s Investors Service said it’s monitoring developments.

For Willem Buiter, chief economist at Citigroup Inc., the election at least means the prospect of an immediate hard Brexit—where the UK leaves the EU with no transition and relies on WTO rules for trade—“is pretty much off the table.” May is now “effectively a lame duck” in the negotiations which will make it difficult to bargain hard, he said on Bloomberg Television.

“It is not actually, from an economic perspective, unambiguously bad news,” Buiter said. “Sometimes uncertainty can increase, but the economy improves because the worst risks have actually been diminished.” Bloomberg

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