Election rocks the boat but calmer waters may follow

Making sense of the financial world isn’t getting any easier – although on the positive side, regardless of the drivers, most analysts are suggesting we’re going to enjoy stability for much of the rest of the year. This is because even in the eurozone there are faint signs that things are getting better – although its growth prospects remain by far the worst among developed countries.

The problem in the UK is the looming general election in May. It will create uncertainty, particularly for the UK stock market, if as seems likely it delivers a stalemate or a government without a real mandate. But that should be a short-term problem that won’t under-mine prospects for a stable year.

The currency situation is difficult to read. The euro has hit a 12-year low against the dollar, and is close to its historic low against sterling, while sterling is relatively weak against the US dollar. This is because the US economy is seen to be performing strongly in terms of growth, with falling unemployment and rising consumer spending strengthening the US dollar. The weakness of the euro reflects a lack of international confidence that the European Central Bank has an effective plan to drive growth. This is overhung by concerns about Greece, and whether the ECB and others will eventually cave in to Greek threats. These range from a euro exit to opening its borders to weaken EU immigration controls.

The forecast is for the euro to fall further and for the rate to remain around where it is now against sterling and the dollar for the rest of the year. This makes European holidays cheaper, but hits agriculture as exporting becomes tougher, while the UK is an open goal for eurozone food suppliers. Spin this out a bit and it’s not going to be a good year for UK tourism. It’s now a lot cheaper for people to holiday overseas, while the UK is costly for eurozone tourists – a blow for some diversification ventures.

Suggestions that interest rates would rise have receded. With inflation just about non-existent, thanks to the plunge in oil and food prices, there’s not the same pressure on the Bank of England to raise the base rate, even though unemployment is falling rapidly. The expectation is that a rate rise will not now happen until the final quarter of the year, and when it does it’s likely to be a modest 0.25%. Base rate has been 0.5% for six years, a long way from the historic average of around 3.5%. This is something businesses don’t need to worry about for the foreseeable future. Inflation is expected to rise again as the oil price begins to move up, probably coming back in 2016 towards the Government’s 2% target. For the UK, low inflation and growth is a good combination – unlike the eurozone that has deflation and little or no growth.

Stability on growth, inflation and interest rates is the formula businesses want, and it seems they’ll have it for the foreseeable future – with the caveat that the election is likely to cause a short-term wobble. There’s also an expectation that commodity prices will rise, but the strength of sterling will limit prospects to take advantage of an export boom.

In the UK we’ve seen employment rise steadily, and this will bring pressure for wage rises, so employers need to be ready to respond. It’s too early to forecast what will happen in September, when the euro rate is set to convert Single Farm Payments into sterling, but if analysts are right in saying the euro will stay at or around where it is now, that could be pointing to a 10% reduction in the sterling value of direct payments, on top of changes as a result of CAP reform.

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