With a mounting number of insolvencies on the British high street and among British firms, and uncertainty over the UK’s future after Brexit, Deloitte’s chief economist Ian Stewart addressed GRR Live London on threats and challenges to the UK economy.
Stewart opened the 22 March event at Stephenson Harwood’s London offices – GRR’s third live event in London – becoming the first non-judge to deliver a GRR Live London keynote address.
His remarks came ahead of a GRR Live London unusually dominated by a rash of UK insolvencies in the retail and casual dining sector, which have visibly hit British high streets, amid concerns over declining UK consumer demand.
Stewart pointed to discussions he was having as part of Deloitte’s regular survey of companies’ chief financial officers (CFO), which showed a significant switch in the balance of optimism between the UK and other economies. “Three years ago, they were very confident about UK growth and very worried about growth in emerging markets. It’s the opposite now.”
He said Brexit was “unsurprisingly” the top risk CFOs feared in the UK, but also weak consumer demand. Brexit was clearly a “headwind” which would lead to a consumer squeeze, he said.
While the UK had beaten some of the direst expectations of economists after it voted to leave the European Union in June 2016, one area where they proved correct was in the effect on the UK’s currency, whose value fell around 15% in the run up to and following the Brexit vote.
That has affected import prices, inflation and consumer incomes. “Inflation has gone from under zero three years ago to 3% three months ago – if your wage growth is flat that’s a big chunk out of your spending power.”
British consumers are facing other challenges, including a low savings ratio which has depressed their ability to sustain spending by saving less. Banks are also cutting back on credit lending, taking away some of the tools consumers use to keep spending.
The UK is coming to the end of a period of almost accidental stimulus, Stewart noted, after banks were compelled to pay out as much as £28.5 billion to consumers who were found to have been mis-sold payment protection insurance. “One banker said to me: ‘We are providing fiscal stimulus to the economy that the government daren’t provide.’ There’s something in that, but that money is pretty much now gone,” Stewart said.
One factor that came to the UK’s rescue after Brexit was falling unemployment. “The UK economy has been an amazing job-creating machine in the last eight years. We beat ourselves up about all sorts of things, but one thing the UK’s done really well is creating jobs.”
Many of those jobs were low-productivity, but “better than no jobs”. He said this was the “single most extraordinary thing” about the post-Lehman financial crisis. “We had the worst squeeze on consumers since the 1870s and unemployment didn’t rise that much.”
But he warned that businesses in the consumer sector would start to see wage pressures begin to build, a development that he suggested was long overdue. “One of the things that all economists have been staggered by is the absence of wage inflation in the last five years. Now we’re seeing signs of it coming through.”
He said that was also matched by millennials finally beginning to switch jobs more freely, after a long time preferring job security in a tough economic climate. “That changed over the course of last year, where there was a sharp uptick in job-to-job changes. Generally if you change jobs you get a 6% payrise – one reason for millennial earnings being low is they haven’t had that mobility, which we’re now starting to see.”
This could cut both ways. “The good news is that consumer firepower is going to get a boost. The bad news is that if you employ a lot of people, you’ll probably find wage pressures rising.”
Political developments, including the outcome of Brexit talks and the identity of the next prime minister, would play a role too. He said the most likely Brexit outcome was not “hard” or “soft” Brexit but “smoothish Brexit, even if a lot of things go wrong”.
While there was widespread relief in the UK last week when a transition period to December 2020 was agreed to follow the UK’s departure next year, Stewart suggested this was premature. “The moment of truth is approaching. Unless in the next six months the UK and EU can come to some sort of agreement, the whole timetable is blown. There was a little too much happiness about the announcement last week – it doesn’t solve the basic problem about getting agreement on principles.”
He noted that betting markets had Jeremy Corbyn, the Labour leader who is perceived as significantly further to the left than any major British political leader in recent history, far ahead of any other candidate to be the UK’s next prime minister.
“I’m finding clients asking us about Labour party policy, and it’s been quite some time since we had those kinds of request. We’re spending quite a lot of time trying to understand it – my own view is that it is very radical stuff, and represents quite a departure from everything we’ve seen from the Labour party for the last 30 years.”
Beyond the UK, Stewart said the “central and possibly underpriced risks” for corporates were a combination of monetary tightening, a very mature recovery and high debt levels in some sectors with overstretched asset values. This was a combination of factors that often leads to recession, he said.
“It’s worth thinking about the fact that this recovery has been going for about eight years,” he said. “It doesn’t really feel like that because it’s not been very exciting, and growth rates have been pretty low – but it’s the second-longest in American history. And generally at this time you’d expect economies to start heading down.”
He noted that markets are beginning to price in higher interest rates, with new US Federal Reserve chair Jerome Powell announcing only the day before Stewart’s address not only a rate rise, but a promise of further rises in future. “That’s not a very dramatic tightening, but more than was expected a year ago.”
“Any investor in most of the last two years has been able to assume central banks would run monetary policy very loose – they were buying assets to try to pump liquidity and basically trying to prop up asset prices.”
“Quantitative easing is starting to unwind,” he added. “This is a huge experiment in economy policy, as huge as took place after the failure of Lehmans when banks started printing money. We don’t yet really understand what the effect of the withdrawal of liquidity might have, but what we do know is that money printing was designed to support asset prices and make money cheap – the withdrawal of quantitative easing should have the reverse effect.”
Stewart also warned about the spectre of protectionism, saying the tenor of US President Trump’s recent moves on trade was markedly different from the selective tariffs imposed by previous US administrations. “I think it’s different this time around. Mr Trump’s rhetoric has been more protectionist than any president since the 1930s.”
He noted that this came from a consistently trade-sceptical outlook from the US president, who as long ago as the 1980s was “very angry” about Japanese car imports into the US.
Stewart also noted that the United States’ justification of its tariffs on national security grounds was “very unusual” and meant it would be hard for countries to contest through the WTO. “That means it’s more likely it could spin out of control.”
He said the tariffs on steel imports were “bizarre”, in that rather than targeting the US’s main global economic rival China they instead mainly hit US allies South Korea, Japan and the European Union, despite invoking national security. (President Trump did announce, only hours after Stewart’s remarks, new tariffs specifically against imports from China).
For Stewart, the rise of China and its economic and political rivalry with the US is the “big underlying story”. He cited, in particular, a US congressional investigation into Chinese copyright piracy.
“I really don’t know what is going to happen,” he said. “I hope countries will realise a trade war would be like shooting themselves in the head. But the provocation has certainly been provided.”
Stewart spoke at GRR Live London, which took place at Stephenson Harwood’s offices in the City on 22 March.
Two further panels addressed the sectors where restructuring work is likely arise in the coming months, naming 2018 as “the year of the company voluntary arrangement (CVA)”. While CVAs are ten-a-penny on the British high street at the moment, panellists warned that they are only half the story when tackling business disruption and that they work best when used as part of a broader operational restructuring.
GRR will be reporting on these panels in due course.