Posted on Tuesday, January 10th 2017 at 01:19pm

John Redwood on the outlook for the year ahead

Some think 2017 will see squeezes on UK real incomes, and a slowdown in growth. The tills of the internet economy have been ringing merrily in the second half of 2016. Will there be a harsh new reality as we travel through January?

It is true that inflation is picking up a bit. The higher oil price has produced price rises at the pumps, and is already visible in higher inflation in the UK, the US and Germany. If oil and other commodities rise further that will boost the consumer price indices more. In the UK it is also the case that the arrival of the Living Wage and the general tightness of the labour market is causing some upwards pressure on prices, especially for those services like small building works where there is insufficient capacity in the market. Like most forecasters, we are expecting inflation to be higher this year than last.

We do not, however, expect such a rise in inflation that real incomes start to fall. Given the current and likely future position on demand we expect earnings to rise, with more overtime, better bonuses, some pay rises and more people in work. This should take care of the inflationary pressures. So far there has not been a surge in shop prices based on the fall in sterling. The pound began to decline against the euro in July 2015, a year and half ago, yet shop prices in December were still lower than a year earlier. It looks as if much of the impact of lower sterling on the price of goods bought from the continent has and will be contained, thanks to very competitive goods markets, and a fiercely competitive UK retail market. UK retailers are often pessimistic about the outlook because they cannot exploit the extra volumes of retail sales that are there to be had. To capture the additional spending pounds the retailers need to offer discounts and great value. The Chinese currency has been falling recently, making Chinese products more competitive again which also helps the drive to keep shop prices low.

Consumer spending ended the year in good form, with retail sales growing at around 6% in volume terms. We would expect that rate to reduce in 2017. It has been possible thanks to some increase in consumer credit. The banks now are sufficiently strong to be able to finance more of a consumer recovery. More individuals feel secure in their jobs and may be looking forward to a pay rise or extra overtime or a promotion. This puts more people in the mood to commit to larger purchases like new homes, cars, new kitchens. It also means more people will spend on meals out and hotel stays. There is reasonable mortgage availability, with many people wanting to buy a home of their own though fewer are able to afford it. The government has promised a White Paper on how to deliver more homes and more affordable homes soon. Car finance has found a popular approach with the three-year rental-style contract. There is nothing wrong with a bit more consumer credit to pay for larger ticket items. It is a necessary feature of growth in a mature economy. New generations of people join the workforce and can borrow to buy longer-term purchases when they start to earn. People who get pay rises might want to take out more credit, without difficulty for repayment.

The Bank of England have admitted they were far too pessimistic after the referendum vote. They need to look again at their model for the trade impact of the EU single market which was one of the reasons they got it wrong. We see consumers in reasonably confident mood. They in turn are dragging businesses into a more optimistic stance as they wrestle to keep up with the demand. That and rising commodity prices is going to assist with the investment rate, as companies see they need to have more capacity and better processes. This looks like a reasonable background for shares as we pack Christmas away for another year. 2017 need not be a cold shower to 2016’s confident results.

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