Economic forecasting is an imprecise science at best. However, some forecasters are a lot better than others, and Samuel Tombs of Pantheon Macroeconomics is one of the best.
Before Tombs joined Pantheon, he was part of the Capital Economics team that consistently did very well in an annual poll of forecasters, coming top of the Sunday Times survey in 2014. He also has considerable academic credentials, including winning a prize from the Society of Business Economists. We’ve therefore decided to talk to him about how Brexit could affect growth over the short and medium terms.
Tombs thinks that “negotiations will go down to the wire” with “not much agreed in the next six to nine months”. The good news is that, if past history is anything to go by, “a deal will be reached at the last minute”. There is “only a small risk” of a complete breakdown, he says, with the biggest risk coming from one of the EU countries vetoing a deal rather than the UK government storming out of talks. Even if talks aren’t concluded within the two years, there is a “strong possibility” that the Article 50 deadline will be extended, allowing more time for an agreement to be reached.
However, the deal reached will be very different from the one the government is currently talking about. Tombs thinks that the UK is likely to end up going for the “soft Brexit” option of EEA membership (or something very similar), with the Norwegian model “the only rational option” especially since it is an “off the shelf” model, rather than a complicated bespoke deal. Naturally, this will involve “compromises on the issue of the European Court of Justice and immigration”. Indeed, “the government’s rhetoric is already changing, as shown by the acceptance that talks over a divorce settlement need to take precedence over a trade deal”.
Of course, while these discussions take place, “the uncertainty will hit the economy by reducing investment”; there are “already signs of an import price shock, with the fall in the value of the pound pushing up inflation”. Sadly, all the evidence suggests that sterling’s plunge is not making British exports more competitive; firms are increasing their prices to compensate for the weaker level of sterling, so the devaluation is only delivering a limited benefit for the economy in terms of output. Slowing economic growth also means that the Bank of England (BoE) is unlikely to immediately reverse last summer’s decision to cut interest rates.
The markets have “jumped the gun over the possibility of rate rises over the next few months”, says Tombs. In his view, two things will have to occur before rate rises are implemented: wages will have to start rising, and the BoE will have to be sure that “business investment is increasing enough to offset the slowdown in consumer spending”. Overall, given the sluggish performance of these key variables, and the “very weak pace of economic growth”, it is unlikely that the Bank of England’s Monetary Policy Committee will vote to raise rates this year”.
Still, he emphasises that it’s important not to be too pessimistic. After all, “consumer sentiment remains robust”. What’s more, if a soft Brexit that preserves single market membership can be arranged, “we could see the pound soaring in value, regaining much of the ground it lost” while businesses would be able to carry out all the investment that they have been postponing over the past year. Given his confidence that such a soft Brexit will indeed be the eventual outcome of negotiations, Tombs’ central forecast is for growth of around 1.5% for this year and the next.
Of course, this rosy scenario is dependent on a deal being agreed that allows unrestricted access to European markets. But if things fall through for whatever reason and we end up with a hard Brexit that involves substantial restrictions on trade, there would be “instant disruption to the UK economy”. Business confidence would “plummet”. Tombs largely agrees with the pre-referendum analysis carried out by the Treasury that projected that GDP could be lowered by up to 6% in the event of an exit.