By now, you’ve seen everyone’s forecasts for 2018. The thing about forecasts, though, is that they are often wrong. This poses the question: how might economic forecasts be wrong next year? And – in a spirit of optimism – how might we get pleasant surprises? Here are three possibilities.
One concerns labour productivity. Having wrongly expected it to rise in every year since it started forecasting in 2010, the OBR slashed its forecasts for productivity in November. It now expects growth of under 1 per cent this year.
Latest figures, however, suggest this might be too pessimistic. They show that total hours worked fell by 0.6 per cent in August-October, which implies that productivity rose by 1.1 per cent in those three months alone. Granted, this might well be a blip. But it might not be. It alerts us to the possibility of upside surprises in productivity.
This isn’t a wholly good thing. In the short term, faster productivity growth might well mean weaker jobs growth. The net effect is ambiguous for household incomes and hence spending: the good news of faster real wage growth is offset by the bad of falling employment. Nevertheless, it might well be good for equities. A productivity pick-up would cause upwards revisions to estimates of the UK’s trend growth rate. That should benefit equities directly. It would also cause the Bank of England to revise up its estimate of the rate at which the economy can grow without generating inflation. This should reduce expectations of higher interest rates, which should also help equities.
A second possible nice surprise might come from the consumer. Most economists expect spending growth to slow next year, as households rebuild their savings and reduce their borrowing – in part because credit conditions are tightening.
But there’s upside risk here, too; the fact that retail sales volumes jumped 1.1 per cent in November reminded us of this.
It’s highly likely that inflation will fall this year. This could reduce savings simply because it means there’ll be less need to top up our wealth to stop it being eroded by rising prices.
Also, consumer spending is in part forward-looking. If households do become more optimistic, spending should therefore exceed expectations. They might do so if they anticipate real wages rising – either because productivity picks up, or simply if they expect a tighter labour market to eventually raise real wages.
Our third upside risk concerns capital spending. Forecasts here are downbeat partly because Brexit uncertainty is causing companies to delay projects but also because of long-term structural obstacles to spending: the scarring effect of the 2008 crisis on animal spirits; companies’ desire to build cash reserves; a lack of monetisable innovations; a fear that future technical progress will render today’s investments unprofitable; and so on.
But there are offsetting reasons for optimism. The OBR and Bank of England believes there’s little spare capacity in the economy. Interest rates are low. Corporate profits (according to the ONS are high), as are cash holdings. And the long stagnation in investment should be building up replacement demand. In the past, these factors have pushed up capital spending. They might do so again.
You’ll notice that I’ve used the word 'might' a lot. That’s because these are only possibilities. In fact, history tells us that there is negative skewness in economic forecasts: if there are really big surprises, they tend to be on the downside. Nevertheless, small upside surprises are a possibility.
