Brexit, interest rates and an economy on a knife-edge
By Helena Page, Consultant

While Q1 2018 was expected to be a quiet one for the UK economy, last week’s news from the ONS that growth has slowed to just 0.1% - the lowest rate in five years – came as an unwelcome reminder of the economy’s vulnerability. Potholes and frozen pipes were not, it seems, the only legacy of the Beast from the East.

ComRes research for London Chamber of Commerce indeed finds the capital to be a microcosm of the national picture, adding to the mounting case – if such a case were needed - for the Bank of England to postpone the next rise in interest rates.

In some ways there is no ‘new news’: the latest figures of the Capital 500 Quarterly Economic Survey, the largest available survey of business sentiment in London, shows that business confidence has been in negative territory for well over a year and that the long-awaited optimism has yet to register.

However, the overall figures mask an important variance within the data: that London’s micro businesses (those with fewer than 10 employees) are struggling to adjust to this stagnant, but nevertheless hostile, economic environment. This is serious and significant, since micro businesses account for the bulk of both business formation (and liquidation) and employment, representing 82% of all UK businesses. They are also typically the most vulnerable financially and least able therefore to cope with sudden changes in the economic landscape. Early analysis suggests that a rise in interest rates of just 0.25% could leave SMEs liable for an extra £355m in interest payments in the first year.

Just as confidence among those smaller firms is elusive, so is cash flow, with a negative balance (the proportion who say ‘improved’ minus the proportion who say ‘worsened’ in the past quarter) of -10%. This compares to larger firms who report a positive balance of +12%.

As if all this were not enough, the latest Capital 500 survey shows that around one in five smaller London firms (17%) say that the cost of borrowing has already increased, compounding increases in other reported business costs including fuel, raw materials and wages. Finally, smaller London businesses were also more likely to scale back rather than increase their investment plants for training and equipment, thus closing a self-perpetuating loop which leaves them with little room to manoeuvre.

Despite this, the state of the economy and the line the Bank of England should adopt remain contested ground: the recent dip in inflation to 2.3% in March and mounting criticism that a low base rate leaves the UK ill-equipped to deal with future economic challenges means the vote over interest rates is rests on an uncertain outcome.

Exclusive ComRes research shows that this divide in view is also keenly felt in the House of Commons – and perhaps confirms the wisdom of Gordon Brown in making his first major act as Chancellor in 1997 to grant independence to the Bank of England.

For, while equal proportions of MPs expect economic growth to improve (32%), stay the same (36%), or worsen (31%) over the next 12 months, MPs from different sides of the chamber hold starkly different views. Three in five (62%) Conservative MPs expect economic growth to improve, yet a similar proportion of Labour MPs (62%) expect it will worsen. This pattern is repeated across all major economic indicators – including inflation and unemployment. It is a hard and fast rule of politics that the party in government is optimistic and the party in opposition is pessimistic. Thank goodness then that interest rate decisions are no longer subject to direct political control.

The economy remains on a knife-edge. Business confidence remains deflated, still under water from the first quarter post-Brexit. If the economic doldrums are a simply continuation of Project Fear, relief may not come until after March 2019 – assuming negotiations run smoothly between now and then. But politics, as Bismarck said, ‘is the art of the possible’. If Bismarck is correct, then hopefully - for the sake of firms in London and beyond - the Bank of England can hold off for a few quarters more before upping rates once again.