UK economy strengthens

A month or so ago, I suggested the Governor of the Bank of England, Mark Carney, would have to write a letter to the Chancellor justifying why inflation is below the Government’s 2% target. This has now happened for the first time. The latest forecast is that the inflation rate will be at zero over the coming months. But unlike the eurozone deflation rate, this is a healthy position, because it will be accompanied by economic growth – which is lacking in the eurozone – and a real value increase in wages.

The big drop in the inflation rate is down to the plunge in food and energy costs. It will now not be too long before we see a measurement of inflation that excludes these two big ticket items. This is the gist of what the Governor is telling the Chancellor. With the general election weeks away it’s doubtless music to his ears, since rising wages and low inflation will deliver a feel good factor at just the right time for the Government.

While low inflation and growth are a good combination, some analysts are suggesting the global market shows a lot of signs for another crash. They believe stock markets have peaked, growth forecasts are optimistic, and that even China is beginning to run out of economic steam. They feel we’re at the top of a cycle, and that as the dip begins commodity prices, including food and energy, will begin to rise again. Time will prove if they’re right, but the new buzz terms adding to a sense of instability, certainly in Europe, include Grexit – a Greek exit from the euro – and Brexit – the cataclysmic pros-pect of the UK exiting the EU after a referendum.
The Grexit issue is rooted in the fact that Greece should never have been in the euro. The entry criteria for it and others were fudged for political reasons, as their economies were never close to meeting the rules. Despite the election of a radical left party in Greece, prospects for a euro exit are low – probably less than 25%. There is no get out clause in the euro, and in theory a country could leave by exiting the EU. However, the rules that were fudged to get Greece in could be fudged again for a ‘temporary’ exit.

But for the other eurozone countries, led by Germany, this would be self-defeating as it would guarantee a Greek default on the billions of euros it’s been lent. A negotiated, if delayed payment schedule will deliver a better outcome – and fit with the political game Greece and the eurozone are seeking to play.

If the odds are against Grexit they are shortening on a Brexit, with suggestions that a returned Conservative government could hold a referendum on EU membership before 2017. The odds of a negotiated UK exit are probably shorter now than for a Greek exit from the eurozone, which is a sobering thought.

Much will be said about that, but it’s not an all or nothing deal. Exit would change many things, not least the CAP and farm support, but the UK would no doubt become part of the European Free Trade Area (EFTA) which includes countries such as Norway that are not EU members, but which trade for the most part with non-existent or minimal tariffs. That’s a debate for the future, but for now prepare to hear a lot more about Grexit and even more about Brexit as the election approaches in May, and beyond depending on the outcome.

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