Immediate “tax cuts” are required but as part of a big policy push.

 

With the UK in the middle of choosing a new Prime Minister against a difficult economic backdrop of rising inflation, potential recession and troubling public finances, the focus of the candidates’ campaigns have increasingly been on whether there should be tax cuts now or sometime in the future.

I would advocate that the UK economy desperately needs lower taxes now. Why?

We unlike any other G7 country have raised taxes, so that combined with a substantial tightening of monetary policy our growth prospects are the worst of any country in the G7 according to the latest OECD forecast. Furthermore, as a result of the pandemic and a reluctance since of a populist government to cut back on the size of the public sector, taxes now represent the highest share of GDP in 70 years. People need to be reminded that the dynamism of an economy is impacted by a rising share of taxation –only private sector activity generates wealth. The former chancellor (one of the two remaining candidates to be PM) actually has raised taxes on National insurance contributions with a planned rise on corporation taxes from 19% to 25% (even though the US has reversed its plan to hike the rate). Such taxes will damage investment, employment and productivity, and ultimately depress growth. If we reversed these tax hikes, and paused the green levies (as recommended by the other remaining candidate) they would boost growth, raise tax revenues and ease the cost of living crisis. In any case, these tax cuts are quite small beer at some £30bn when compared with forecast errors  or in the context of a £2trn+ economy, particularly when one remembers the scale of fiscal drag with the freezing of various tax thresholds and the level of inflation which have boosted tax revenues without a matching rise in public spending. It hardly makes the advocate, a tax cut “slasher” or Laffer Curve supporter.

What of the public finances? Well thanks to the responsible policies of the previous two administrations before Brexit, this country has built up a lot of credibility in the market. Thus there is a strong case for treating the pandemic debt separately as like with War debt, which can be paid over many decades. In any case, our public debt burden at 88% of GDP compares favourably with other G7 countries, only being bettered by Germany at 71% of GDP – Canada 102%, France 113%, US 126%, Italy 151% and Japan 262%. Moreover the maturity of the debt is still very favourable at an average maturity of 14 years. Although with recent gilt sales, the gilt share owed to overseas investors has risen to 28%, this is still very manageable.

The strongest argument put forward against tax cuts has been the threat of a further boost to inflation, which on the CPI measure has already reached a 40-year high of 9.4% in June. (As an aside I warned back in my blog of February 2021 that we were set for a prolonged rise in inflation thanks to the impact of Quantitative Easing and pointed out later as a result of global supply issues that the UK and other G7 economies were set for double digit inflation without it falling back sharply in contrast to the majority of economists who thought it was transitory and had no monetary cause). It has been argued that tax cuts would raise aggregate demand and therefore increase inflationary pressures, ceteris paribus. However, if we cut taxes such as NICs and Corporation taxes, rather than say personal income taxes, they will increase aggregate supply so dampening any Keynesian demand pull inflation. Furthermore, subject to what happens in Ukraine and to wages in this county, inflation should subside in 2023 as a result of a substantial period of Quantitative tightening, notably in the US and the UK. 

Talk of a boost to aggregate supply moves me on to emphasising that tax cuts would be just one supply-side measure needed to drive the UK’s growth rate higher without raising inflation. This includes, lower and more suitable regulations post-Brexit, reform of a dysfunctional NHS, reform of a severely bloated civil service, the reining in of Trade Union power, increasing in immigration in sectors where more labour is required, and finally a comprehensive overhaul of energy policy.

So what about interest rates? Well they are headed higher than one would want thanks to the failures of the Bank of England to reverse QE earlier enough. However, despite the pain for some, interest rates should be raised to more normal levels. Low interest rates have been responsible for causing asset bubbles in property and equities, so causing intergenerational unfairness. Higher interest rates will help to take the heat out of the housing market, at last importantly reward savers a fair rate which will facilitate higher investment, and put Zombie companies under financial pressure.

Lies, damn lies and statistics - from covid to GDP data

 

In today’s blog I want to talk about the abuse of statistics in the media with a focus on UK GDP. We have got used to the media blasting us with statistics during the covid-19 pandemic, as journalists with little statistical knowledge use the data without interpreting or analysing them properly. The best example relates to the covid data, whether it is cases, hospitalisations or deaths. Much of the media has used them for their own agenda to attack the government to portray it as incompetent and the sole reason why in their eyes the UK has had a “bad pandemic”.

 

The reality which has become clearer over time is that there are a plethora of reasons for the UK’s experience including mistakes made by the UK government but also by the health authorities (NHS and PHE), by scientists and as a result of underspending on health over several decades. However there is also the health of the nation in respect of obesity and related diseases such as diabetes, cardiac disease, cancer, asthma etc with the UK considered one of the worst in Europe. Then there are non-health factors such as population density and global connectivity, where the UK and particularly London rank at the very top. And finally the data is not compatible on a country-by-country basis anyway with countries using different definitions of for example when a person dies of covid (think Spain with its very narrow definition of a covid death when compared with the UK or other European countries) or because a country is either incapable of recording all or the vast majority of deaths (think India, Mexico or Brazil or indeed most African countries) or deliberately under-records such data (think China, Russia, Iran or North Korea). The WHO estimates that up to 8 million deaths can be attributed to covid globally, which would represent a massive under-recording on the official 3.4 million death toll.

 

In the case of the UK, this under-recording is a relatively small number. In any case latest official data shows the UK does not even make the top 15 countries on deaths per capita, with many mostly East European, and some West European and Latin American countries comprising the top 15. And if we focus on excess deaths per capita which can overcome some of the data issues previously mentioned. the UK is not even in the top 25 worst performing countries for which data exists – The US, Russia, Brazil, Mexico, South Africa, Italy, Portugal and a plethora of East European and other Latin American countries are all above us!

 

However my blog today intended to concentrate on GDP and in particular in challenging the media consensus that the UK government’s “bad pandemic” was also reflected on the economy and in particular in GDP growth. One frequently still reads headlines saying that the UK economy was the worst performing country in the EU or the G7.

 

For 2020, official ONS data shows that UK GDP fell by 9.9%, which by the end of Q4 left the economy some 7.8% below its level prior to the pandemic at the end of 2019. This would represent a collapse without modern precedence – even during the Global Financial Crisis, UK GDP fell by a mere 4.3% in 2009. Moreover, Eurostat data shows us that EU GDP fell by an average 6.1% (and Eurozone GDP by 6.6%) with only Spain, down by 10.8%, worse affected than the UK. However the compilation of these statistics is not comparable as I will explain below. Once adjusted for a fairer comparison, GDP in the UK is estimated to have fallen by a more modest 7.5% leaving it in a better position than not only Spain, but a number of other EU countries including Italy, France, Greece and Croatia.

 

The need for a sizeable adjustment has arisen because of the different ways the UK and the EU treat so-called non-market output - approximately the output of the public sector. GDP, which for all its faults remains the single best summary of national economic activity, effectively measures the aggregate output of all sectors of the economy. This is easily measured in the case of the private sector where we can look at the turnover of a business. But in the public sector, particularly in health and education, it is very difficult to measure output. In the UK, the ONS overcomes this by looking at a wide range of detailed data such as the number of pupils attending school, the number of hours teaching in schools, the number of people visiting a GP, and the number of operations taking place. These measures were introduced to better measure not only output but to assess productivity in these sectors and whether the UK was getting good value for money for any increased government spending.

 

During the pandemic, schools were closed for a prolonged period and many operations were postponed. As a result we saw a big fall in the output of public services here in the UK. Indeed some 2.4 percentage points of the 9.9% fall in GDP in 2020 can be attributed to a fall in public sector output. Within public output we saw Education output fall 16.4% and Health & Social Work output by 8.2%. Nevertheless the UK data greatly exaggerated the fall in output so the ONS has been adding new indicators since to take account of pupils working from home as well as test & trace activity and covid vaccinations, although they are yet to be applied to 2020 data – only current monthly data

 

By contrast in many other countries such data is still not available or not used by national statistical agencies (despite the urging of various international institutions) so they estimate the output of such services by measuring the input ie looking at how much money was spent on them even if fewer services were provided. This is the approach taken by nearly all EU countries and meant we did not see the dip in the output of public services that genuinely did happen during 2020 throughout most of the EU.

 

Another useful measure to use that largely overcomes these intra-country comparison issues is nominal GDP growth, although they miss important volume movements seen in real GDP data. Nevertheless, we can see for the G7, the UK GDP fall is in fact less than in Germany, Italy and Canada, albeit higher than in France. In the US and Japan where the lockdowns were far less severe, overall economic activity was affected much less. So the bottom line is that UK GDP was badly affected by the pandemic particularly as our lockdown was notably long and tight, but the fall was not the worst by any means in the EU or G7.

 

In my next blog I will talk about UK GDP in 2021 and the expected sharp bounce-back in growth which is likely to be the fastest in the EU or the G7. 

Quantitative Easing and its dangers in an inflationary environment

Does a large budget deficit and the associated public debt burden really matter that much if the Bank of England finances it through asset purchases?

 

It is generally agreed during this pandemic that the government should spend vast sums of money to maintain income levels and prevent unemployment rising as much as possible so avoiding potential “scarring” of the economy ie a permanent reduction in productive economic output. There are also times dependent on the state of the economic cycle but also when investment in infrastructure and other forms of capital spending including on humans that means it may be appropriate to run a significant deficit.

 

If a budget deficit is financed through the issuance of government bonds which are purchased by investors (pension funds, insurance companies, households and overseas investors) then the degree to which one can do this successfully will depend on the existing policy credibility of the country, how much more is to be borrowed, the potential growth rate and the global background including the level of world long term interest rates. If a country has to borrow at very high interest rates (whether it is from abroad or not) then the debt burden could escalate and the interest payments will account for an ever higher portion of government spending so potentially squeezing out other spending.  Indeed a simple equation used in economics proves the debt burden will likely “snowball” ever higher if the (real) average interest rate of borrowing is greater than the (real) GDP growth rate.

 

In the UK, the government was in a very strong position to borrow coming into the pandemic aided by strong policy credibility thanks in part to its actions to tackle the deficit previously as well as by the very low global long term interest rates. Moreover, it has not had to borrow from abroad, and the borrowing has been very long-term so avoiding any rollover risk, reducing interest rate sensitivities and maximising the use of low borrowing rates now. Average debt maturities are around 13 years albeit on the decline.

 

It was conventional theory (as I learned it) that a country should borrow to fund any fiscal deficit (i.e. debt financing) if it can rather than finance it by printing money (ie monetary financing). Printing money was a sure way to generate inflation and lead to all the adverse consequences associated with inflation. The extremes of such a path which resulted in hyperinflation were of course seen in the Weimar Republic and in more modern times in Zimbabwe and Argentina.

 

However there are now new arguments which are complex and controversial, that says Bank of England purchases of assets, principally government bonds, known as Quantitative Easing (QE) may be a sort of free lunch. It is also referred to as “unconvential” monetary policy. As a result, increasingly, the UK deficit (and elsewhere) is being financed by QE. It still entails the creation of (electronic) money known as Reserve Money which is part of MO base or narrow money. However, it might not translate into M2 broad money (i.e. remaining largely within the financial sector) preventing it from largely entering the real economy and which is used to buy goods and services, and therefore affecting inflation. Such funding is approaching one-third of the gross public debt burden and being in the form of central bank reserves they only pay an interest rate of some 0.1% much lower than gilt yields.

 

The empirical evidence from the first big wave of QE after the global financial crisis (GFC) is that QE was not inflationary with M2 growth not growing excessively. However, the GFC was a deflationary phenomenon. And particularly important was that banks did not create new bank loans so preventing the operation of the classic money multiplier – they preferred to shore up their own balance sheets and regain profitability. 

 

However, there are real dangers that this will not be the case this time after the pandemic. The world is a potentially much more inflationary place after the initial deflationary impact of the pandemic itself. This reflects explicit coordination of expansionary monetary and fiscal policies (led by the US, but also the UK and the EU), the increased bias it seems of  central banks towards inflation including higher inflation targets (underpinned by a reluctance to raise bank rate given the massive amount of QE), the move back to de-globalisation (and no favourable China deflationary effect) and the disruption of international production chains. Indeed evidence is already concerning. Most notable and most importantly is the US, where M2 growth exceeds 20%yoy, input prices and commodity prices have surged, there are supply constraints and shortages (even in the labour market), and retail price inflation is also now picking up markedly. Nevertheless, some prominent economists still think inflation will not persist with classic “wage-price spirals” not taking off. I am not convinced.

 

So to sum up QE is really an experiment. Under the right circumstances it looks like it can play an important positive role, but we are now in different times than after the GFC and there is a real risk that inflation will not only rise to higher levels but stay there without tough action.

 

 

 

 

UK financial services post-Brexit

 

Prospects for the UK financial services sector remain rosy.

 

The UK financial services sector (including related professional services) accounted for over 10% of GDP and employed more than 2.3 million people at the end of 2019 (Source: CityUK). Moreover the financial services sector is the largest UK taxpayer (more than 10% of all tax revenues) and the biggest exporting industry generating a trade surplus of US$77bn in 2019 (including related professional services some US$102bn) - the largest in the world.

 

Yet in contrast to goods and manufacturing, and even the tiny fishing industry (accounting for 0.02% of GDP according to the ONS) there was barely a mention in the Trade and Co-operation Agreement (TCA) bar a Memorandum of Understanding which so far has largely been limited to derivatives so as to maintain EU market liquidity. This was no oversight. The EU has a large goods trade surplus amounting to £97bn in 2019 with the UK but a services deficit of some £18bn with us (rising to £44.3bn for financial and related services alone, according to the ONS). In fact over a third of our financial services exports currently go to the EU.

 

The EU countries have longed to see EU financial market business move within its sphere having viewed the City of London with suspicion and envy, and a belief that such activity should be in the core Eurozone. Its aim in the negotiations was if possible to avoid such agreement whether this would be in terms of mutual recognition or in some form of equivalence - other than dynamic alignment - so that it could chip away at London’s dominance of the European financial markets. (The City accounted for nearly 80% of its EU foreign exchange trading, three-quarters of derivatives trading, 85% of hedge fund activity, and 60% of capital market business). It has largely viewed this strategy as based on a zero sum game when in reality there are costs associated with such a policy of market fragmentation in terms of the loss of economies of scale, and of expertise and the knowledge that London has. The EU’s approach was greatly facilitated by a poor negotiating strategy by the Tory government under PM May and a “Remainer” Parliament (and other institutions) that resulted in the UK giving into the sequencing of negotiations preferred by the EU that resulted in the Withdrawal Agreement and the loss of our negotiating strengths including payment of the £40bn divorce bill, the effective splitting of the UK between GB and NI, and the granting of freedom of EU residents to reside in the UK.

 

Anyway the damage to the City has been nothing like most commentators had predicted, just like with Brexit more generally. Many typically forecast the loss of up to 100K or even 200K jobs. A London Stock Exchange Survey in 2016 concluded that 232K financial services could leave the UK. By contrast I suggested that it would be more like 10K and that the City would continue to prosper in various reports and speeches that I have made (eg Brexit and Financial Services 2017). The reality is that some 7.5K jobs had left according to the EY Financial Services Brexit Tracker at the end of 2020. It also states though that some £1.6trn assets had been transferred – a figure that has increased since.  Moreover the number of people working in the City has continued to rise since the referendum result. An FT Survey of 24 large international banks and asset managers in December found the majority had actually increased their London headcount over the past five years.

 

There will be further negotiations between the UK and the EU on access to financial markets in the coming months that may yield further agreements in areas such as reinsurance but they are likely to be modest. The EU will only agree to anything if it clearly benefits them. The EU’s preference is for the City of London to follow EU regulations very closely. But as Andrew Bailey the Bank of England governor recently said we should not become a rule taker, which would not only lead to us losing the opportunity for better and lower regulation but also as Michel Barnier, the EU’s Chief Brexit Negotiator said any access to EU financial services is a gift from Brussels than can be withdrawn freely – clearly one cannot operate under such a threat. We should be focusing on how we can protect our position as a global financial powerhouse. And anyway despite diverging from EU rules and the loss of passporting, international law protections will still allow financial institutions to provide certain cross border services to wholesale clients

 

The City of London is one of only two leading global financial centres (See the rankings in the Global Financial Centres Index produced by Z/Yen consultancy) and its future lies in being a global centre, being innovative and not hampered by unnecessary regulation and high taxation. We are competing against the likes of New York, Tokyo, Singapore, Shanghai and even Dubai or Bahrain. Not so much against Frankfurt, Paris, Amsterdam or Dublin, none of which can be viewed even as serious rivals as a leading European financial centre. For example in the rapidly growing fintech sector, our rivals are really only Silicon Valley, Hong Kong and Singapore.

 

The best approach is what Barney Reynolds of Shearman and Sterling LLP has dubbed the World Financial Centre Model where we go it alone and design a more attractive regulatory framework, freed of the EU’s restrictive policies and process-driven approach. In light of this, UK Chancellor Rishi Sunak is promising a “Big Bang 2.0”. While good governance remains paramount there is a desire to cut unnecessary red tape with changes to the EU rulebook such as on MIFID2, and Solvency 2 for insurance companies. Also recommended as by the Institute of International Affairs is that the UK form alliances with other major financial centres through multilateral mutual recognition. Switzerland and Singapore would be two obvious financial centres.

 

Pivotal to the success of the City going forward will be the Fintech sector. It is worth £7bn employing over 60K people in the UK and includes brands such as Monzo, Revolut and Starling Bank. An independent Review of the sector led by  Ron Kalifa was launched in the Budget of March 2020 to support the City’s competitiveness through “ensuring it has the resources to grow and succeed, conditions that are right for the widespread adoption of financial technology, and that the UK’s global reputation for innovation is maintained and advanced. Also important is Green Finance where again it is one of the world leaders alongside specialist financial centres Amsterdam and Zurich. Over the last three years the amount raised in green bonds has almost tripled from £8bn in 2017 to £22.4bn in 2020 with 139 listed on the London Stock Exchange. There are also now 22 green funds listed on the LSE. Furthermore the UK is leading the world in committing to reaching net zero carbon emissions by 2050. It has committed £12bn investment in green finance over the next 5 years among other things.

 

The City has a long history of resilience, adaptability and reinventing itself. It survived the 1930s and two world wars. It saw the rise of the Eurobond market in the 1960s as a result of US balance of payment controls. And it prospered after ‘Big Bang’ which was launched in October 1986 by the Thatcher government with its extensive market deregulation. Finally, it was unaffected by the UK’s decision to join the Euro. In any case despite the lack of agreement the City prepared well for Brexit and I have no doubt that the right steps will be taken to ensure its future prospects are rosy.

 

 

 

Tory election campaign failed not only politically but also from an economic perspective

The reasons for the failure of the Tory election campaign have been well rehearsed. They include the decision to make PM Theresa May the focus of their campaign while stressing the need for "strong and stable" government against the incompetence and extreme policies of Corbyn. But May lacks charisma, is unable to think on her feet and does not have a common touch. And the strong and stable mantra was an insult to the electorate's intelligence.  In contrast Corbyn was grossly underestimated as it was forgotten he is a veteran campaigner and was very comfortable in the election campaign and able to convince a  very impressionable younger generation of his supposed sincerity and caring for the poor.

This was reinforced by the respective manifestos, with the Tories being too honest of the challenges ahead but also failing politically to realise the electorate has had enough of austerity and desperately wanted change. They also failed to mention the need for social justice that May had dwelt on when elected Conservative Party leader. In contrast Labour judged the mood of the country better and got its populist, anti-austerity and generally more optimistic message over better  - through social media in particular - that there was a way forward even if their sums did not add up. On top of this the reversal of the so called dementia tax did nothing for the Tories strong and stable message. Finally, Labour managed to sideline the issue of Brexit, the original reason for the calling of yet another election.

But the Tory manifesto also failed from an economic perspective. While the Tories were honest in acknowledging some of the key economic challenges ahead such as the need to tackle social care, the need to deal with an aging population and also to promote fairer intergenerational equity (see blog 22 October) it failed overall by not fully abandoning austerity (despite recent loosening of balanced budget targets) and promoting a fiscal stimulus.

In a previous blog on 10 October I talked about monetary policy having been overworked, of low interest rates providing the opportunity for fiscal stimulus and the positive side effect of increased government spending on aiding redistribution of income. It would also raise growth at a time when GDP growth is finally slowing without the risk of the economy "overheating", and by prioritising infrastructure spending boost the supply side of the economy and raise very low productivity growth.

International financial market developments are also very supportive of a good old-fashioned Keynesian stimulus. Global bond yields have dipped again leaving real bond yields of advanced countries in the US, UK, Eurozone and Japan low or even negative. The reason for this is attributed to the so-called "safe asset shortage". The idea is that there is a large excess global demand for safe, liquid and highly tradeable government debt for whatever reason. It is thus argued these countries can raise spending without pushing up their own government bond yields rapidly, a sort of " free lunch". Eventually though yields will creep up not least because the shortage will erode as bonds issued rise to fund higher budget deficits.

Another factor in weakening the case for continued austerity is the demolishing of the now-infamous 2010 economic paper 'Growth in a Time of Debt" by Reinhardt and Rogoff. It claimed that a 90% government debt to GDP ratio is a critical threshold at which a fiscal crisis like seen in Greece could occur. But the data was proven to be flawed and most now argue that Greece is a special case among advanced countries.

With a number of years fiscal austerity, front-loaded into the 2009-2011 period, the fiscal deficit was brought down to around a third of what it was in 2009 so that it stands today at some 3.5% of GDP.  This has greatly boosted policy credibility and given the scope for significant fiscal easing without the need to raise taxes and so able to take advantage of favourable market trends. This may not last and certainly the UK must be cautious not to raise spending too rapidly or much on current spending which could damage credibility. It should be noted that the UK has not run a surplus since 2001 and it is much easier to raise spending than cut it. Remember also that the UK's debt to GDP ratio is still rising and approaching 90%, notwithstanding the improved debt maturity profile. While there are signs that the global economy is picking up, the next crisis or downturn may not be far away. For the UK the concern is the uncertainty of Brexit. However, for the UK and other advanced countries fiscal stimulus will give more scope to raise interest rates which will give space to cut rates in the next downturn.

So there is both an economic and political case for fiscal stimulus in the UK.

Economic madness to vote Labour

Only someone who is economically illiterate ( sadly the vast majority of the electorate) or supports the Marxist cause would rationally vote Labour these days. The release of the Labour manifesto for the general election on June 8th would take us back to the 1970s with hyperinflation, mass unemployment, regular strikes, an escalating debt burden, high interest rates and low or negative growth. In fact it would be worse than then. A fully fledged socialist agenda would be worse now in this globalised world when capital and labour can move where it wants. We saw in France, for example, how Hollande had to abandon his Socialist policies repeating Mitterand's mistakes in the 1980s.

One of Labour's most popular policies would be a massive increase in spending on the NHS. Forgetting this is not necessarily the solution to its problems, the sad fact is there would not be the money available in all but the short-term.  Sadly this commitment along with extra spending elsewhere totalling nearly £50bn will not be matched by the increased revenues. As I have said many times, and is corroborated by the highly respected and independent Institute for Fiscal Studies, tax increases from corporation tax and on personal incomes on those earning over £80k will yield very little in the short-term and probably a negative amount over the medium-term. Both capital and labour is ever more internationally mobile and will go to where these rates are lowest. It may have escaped you for example that corporation tax revenues have rocketed in the UK recently despite the tax rate falling.

On top of this, the manifesto confirmed that a Labour government would renationalise the railways, the Royal Mail and the National Grid and even Water, undoubtedly a superficially attractive policy given the various problems and issues there have been in these sectors.  This is despite the overwhelming evidence that nationalisation is far inferior to privatisation. The answer is clearly better regulation. Such a renationalisation plan would be a massive undertaking akin to implementing Brexit. The biggest concern however would be how it would be funded. It seems by borrowing! This would only add to the national debt and result in massive increases in interest payments (and less money for public spending)  and a  'crowding out' of private investment through higher interest rates. Such tax, spend and borrowing policies would be especially bad as we leave the EU and need to boost our competitiveness.

The polls may well narrow as some of the electorate become seduced by some of these unaffordable policies, especially among the idealistic young that do not remember the 1970s. But while Corbyn managed by an abused election system to become leader of the Labour party, he is very unlikely to become PM. The issue of his lack of competence  and of his senior shadow cabinet has been there for all to see in this election so far. Related to this too is the lack of economic credibility that has been built up from the disastrous spending policies - but far more modest than is planned now - of the Blair/Brown government years that was the underlying cause of the bad public finances that the coalition government inherited. And if this is not enough, Corbyn's ambivalence on use of Trident even though he would spend the money on renewing leaves grave doubts of his suitability for the top job. The electorate votes typically on the relative suitability of a party leader to be PM and on its party's economic credibility. It is no contest.

Brexit and financial services

There is no sector more important to the prosperity of the UK economy than the financial services sector. Together with related professional services like legal, accountancy and management consultancy, the sector accounts for 12% of UK GDP and employs 2.2 million people. It also accounts for some £67bn or 11% of total government revenues, and generates £77bn in net exports - making UK the world's largest net exporter of financial services.

The realisation that the government is pursuing a hard or as I prefer to call it clean Brexit that involves the UK leaving the single market (and customs union) has raised fears that financial services will be severely damaged especially if also there are no transitional arrangements.

But it may surprise many to know that there is no single market for services and certainly not in financial services. There is no single banking market, no single insurance market, no unified capital market, and no European stock exchange.

The issue of passporting has received a lot of publicity when discussing financial services post-Brexit. Passporting was designed to overcome the lack of a single financial services market by allowing a financial institution authorised in one EU member state to market financial products in other EU countries. It is open to non-members states too in theory at least, and after Brexit, UK and UK-based banks and finance companies would be free to set up subsidiaries (if they have not done so already) in the EU to trade throughout, though the presence would have to be meaningful, something to be debated. Another route to maintaining business in London will be so-called "equivalence" of regulation. This will be useful for the City in any transitional arrangements agreed, though I do think we should not be tied to this in the longer run, particularly as we will have no say on the regulations, and also that we will likely go down the path of greater deregulation.

Even under this passporting system, retail financial services remain virtually entirely national and heavily protected. So leaving the EU will have no impact here for the UK. With respect to the wholesale sector, banks do not need a passport to access the City's foreign exchange market or it's interbank market, while companies can buy reinsurance at Lloyd's or do business with corporate financiers in London. It has been estimated that just 20% to 25% of wholesale business is related to the EU and only part of that is facilitated by passporting.

So what about the issue of the settlement and clearing of euro-denominated instruments I here you ask? The trading of such business would stay in London, as this is where the liquidity and infrastructure is. Europe is just not a credible competitor. But the eurozone has long coveted the euro-denominated clearing business which - along with non-euro clearing - is dominated by the LCH clearing house in London. The European Central Bank previously attempted to take such activity back in a failed landmark legal case in 2015. But there are now potentially renewed attempts to do so. Yet there are real dangers to moving the business within the eurozone. Many experts have noted a forced repatriation of the clearing would increase systemic risk and substantially increase the costs of clearing.  Economies of scale allow for so-called "netting", a process that reduces margins. Also such denying of London the right to clear euros would have to be applied globally, but this would likely lead to retaliation especially from the US.

Despite the jostling among European cities including Paris, Frankfurt, Berlin, Luxembourg and Dublin, there is no real rival in Europe to London as a global financial centre. It's dominance is only threatened by New York as one can see in more detail From Z/Yen's excellent Global Financial Centres Index report. London is supported by its expertise and knowledge in financial services and key support services such as Law and accountancy; by the use of the dominant English language and the attractions of living in a vibrant and exciting city; by its infrastructure; by low taxation; and the sheer size, depth and liquidity of its financial markets. The biggest challenge remains from New York which is supported by a larger domestic economy, and could get a boost from new US President Trump's plans for greater deregulation including getting rid of Dodd-Frank which was imposed seven years ago, and by lower taxes.

There is a growing realisation in some quarters of the continent that trying to hurt the only large financial centre in Europe will damage the EU perhaps as much as the UK. Germany's finance minister Schauble warned against punishing the UK generally not least because of the unrivalled London financial centre. A leaked European report warned that failing to protect the City would indeed hit Europe's economy.

The City of London is very resilient, agile and great at adapting. It survived the 1930s and two world wars. It prospered after Big Bang and was unaffected by the UK's decision to not join the Euro, becoming the undisputed financial centre of Europe despite the fears of many. I remain optimistic even if the EU does its best to undermine it, that the City will remain pre-eminent being highly innovative and doing what is necessary to retain its competitiveness perhaps through lighter regulation and lower business taxation. It can escape EU regulation on Bankers' bonus caps and the financial transactions tax and perhaps impose lower capital buffers. It will be important however to remain open and in particular retain full access to talent overseas which has been acknowledged by the government, with even the Labour opposition realising this with its purported plans to introduce regional immigration plans.

There will certainly be some shifting of business but it will be on a small scale compared with the impact of other developments and evolving new areas of business and new products eg renminbi-related products or in the already thriving fintech (financial technology and innovation) industry.  London will remain one of the two global financial centres.

UK economic growth prospects rosy in the short-term and in the long-term

Late last year I wrote that UK GDP would grow by nearly 2% a figure that compared with a consensus of some 1.2% then and as of yesterday about 1.3%. My optimism surprised many. Today I am a little nervous as the notoriously inaccurate/pessimistic Bank of England revised up its forecast to 2% also, having forecast it at 1.4% in November and just 0.8% in August. Who knows they might even hike it back to the pre-referendum forecast for 2017 to 2.3%! And now watch the consensus forecast rise too because of the classic group mentality.

My own optimism that growth would barely slow if at all in 2017 was based on a number of factors:

Firstly, consumer spending will undoubtedly slow somewhat as a result of the squeeze in real personal disposable incomes from higher inflation via a weaker exchange rate but not as much as expected. Consumers not surprisingly remain pretty confident in this new pre-Brexit world and continue to spend as we have seen from Q4 data. Expect consumer borrowing to rise and the savings ratio to fall back even more, while unemployment will remain close to current lows, facilitating a rise in consumer spending close to 2% from 2.8% last year.

Secondly expect the weaker pound to have a significant impact in raising net exports. Competitive devaluation can still be effective in driving export volumes up and I believe we can see the same positive impact as in 1991. This is likely to be reinforced as a result of only a weak upturn in inflation here and a pick up in global growth. Indeed business surveys have reported strengthening export order books.

Thirdly the drag from a tight fiscal stance was eased a little in the Autumn Statement which loosened the fiscal rules. We are seeing a modest increase in infrastructural investment spending.

Fourthly,  the monetary policy stance will remain easy with base rates unlikely to be raised from their ultra low 0.25% anytime soon. The Bank is likely to remain wary of going too soon in hiking rates fearful of the consequences, and is reinforced by its relaxed views about inflation, particularly with respect to any feed-through into wages or inflation expectations.

Finally, the economy had a strong growth momentum going into 2017 with Q4 GDP up a preliminary 0.6% y/y. Simple base effects will leave average growth higher this year than if we had seen a slowdown as others expected for H2 2016.

In a future blog I will look at our longer term growth prospects which I believe are good.

A clean Brexit is likely to be the best option

I'm increasingly convinced that the best way forward for the UK will be what is portrayed as a hard Brexit, although given its negative connotations I would prefer to call it a clean Brexit. While we can't completely rule out the prospect of staying in the customs union and some access to the single market, the intransigence of the EU authorities and undoubted complexity of the negotiations with 27 countries plus other regional authorities mean a clean and swift break will probably be the best way forward. In any case I would argue joining the European Economic Area which involves continuing to pay into the EU budget and accepting numerous rules and regulations including free movement of labour would be a betrayal of the referendum result. Furthermore if we retained membership of the customs union this would preclude the prospect of securing free trade arrangements with the US, Canada, Australia, New Zealand and many others that have emphasised their keenness to do so and quickly. And remember food prices would fall if we left the customs union.

There is also a reasonable case for some ultra-Brexit whereby we trade not just under WTO rules, but with zero tariffs on all imports into the UK, yielding massive gains to consumers, although personally I would prefer to retain bargaining power in free trade negotiations.

Even hopes for an interim transitional deal involving membership of the EEA will be difficult to secure in negotiations. The EU negotiators are very keen to penalise the UK and see this wrongly as a zero-sum game hoping to take business away from us to themselves.  As a result, they want to discuss payment for leaving first, then the main deal, and then any transitional arrangements. Even a deal on existing EU workers in the UK and vice versa will have to wait they say.

And I certainly do not subscribe to all the pessimism we see in much of the media regarding the result and future prospects. So far on the narrow measure of GDP, Brexit has not been a disaster as Remainers suggested it would. I personally said there would be no recession even though the economy was slowing even before the referendum. Indeed in 2016, GDP will have grown by at least 2% (with an upwardly revised Q3 GDP from 0.5% to 0.6% quarter on quarter showing there remains strong momentum) and I believe we will see growth of not far short of 2% next year despite the impact of inflation on real disposable incomes. The idea that consumer confidence would be battered by the vote was never credible. Such an outturn would leave growth higher than all major Eurozone economies, the US and Japan.

But equally important is that the referendum settled once and for all our status with respect to the EU. It has given us back our sovereignty. Already we see this in parliament with the debates about Article 50. In addition it importantly gives us back control of borders. Of course we need to have access to top talent from overseas to sustain our financial services industry and even labour from the Balkans to maintain our fruit picking, but we need to maintain controls to avoid the destabilisation of the society and diminishing of British values. Although we also need to improve British education and labour skills. Finally we need to prevent the awful terrorist activity seen in Germany, France and Belgium and thankfully largely avoided here. This is due partly to our superior security services and somewhat better integration, but also so far to largely avoiding the ridiculous open refugee policies of Merkel.

And I'm also optimistic because we will be able to be a champion of free trade again as happened in the nineteenth century after the abolition of the Corn Laws. There is no doubt that the Anglo-Saxon world is desperate to negotiate trade deals with us. And further down the line once the EU realises its mistakes of protectionism and unneccesary rules of free movement of labour we can secure free trade deals with them too.There is no doubt that the UK is well-placed to take advantage of a post-Brexit world. For example according to the Indigo Index, which seeks to measure a country's entrepreneurial eco-system, and therefore it's potential to adapt and develop, it is ranked fifth out of 152 countries - only behind small countries in Scandinavia as well as Switzerland. This does not mean we should stop still. We need to go further in boosting infrastructure and education, but also cutting taxes and shrinking the public sector.

Anyway I wish you all a merry Christmas and another successful and happy new year!

Time for the "Baby Boomers" to give something back

While there is little doubt that it will be Brexit - and the success thereof - that will define Mrs May's administration, a secondary theme will be that of how far she succeeds in implementing greater fairness in the country - in her own words  "a country that works for everyone". While every PM in the last 25 years has made similar noises she has seemed to have a greater commitment. And there is evidence that the policies of the last Cameron government are all being reevaluated not least in terms of their fairness. But, no doubt though that any politician should be judged by actions not words!

An important aspect of the fairness agenda, but one not as often mentioned as others, is what economists call intergenerational equity - a concept of fairness between children, youth, adults and seniors. It is a term often used in investment management but has become more prominent in the world of economics in recent years because governments have run up large deficits and debts which have benefited a current generation through welfare benefits, tax cuts and government jobs, potentially at the expense of future generations.

Baby boomers refer to a cohort of the population born between 1946 and 1965 when the birth rate materially accelerated. It was thought that because this cohort was very big, a person born then would suffer in terms of greater competition for jobs and housing. But the reality has been that they have been the beneficiaries of a number of developments and events at the cost of other mainly future generations.

The welfare system may be seen as having a natural life cycle. Thus we tend to mainly benefit from it in our youth and in our old age. Conversely our contribution to government revenues tend to occur during our working life in between. Keeping this in mind, baby boomers, as the biggest group, when they started working, they tended to push the dependency ratio sharply down, ie the number of people earning rose relative to the number of dependents, whether the young or retired. During this period, roughly from Thatcher to the coalition administration, the government was able to spend more freely because of this, and also over and above this they spent during the Labour government years stacking up debt for future generations to pay for. But now that the baby boomers are increasingly retiring, the dependency ratio has in the last couple of years increased significantly. Immigration actually delayed this phenomenon, but it will continue rising for a long time yet. This means that those working now have to pay for more dependents than in the past and for excess spending in the Labour years.

This demographic trend is storing up massive problems for governments not just in this country but most of the developed world, most notably in Japan and Germany. Moreover, baby boomers have benefited from a number of other events.

In the housing market, baby boomers were relatively easily able to afford to get a deposit and buy a house. Today so many people cannot do so. In fact on average it takes them 22 years to save for a deposit! In pensions they have done well too. Pensions have been heavily protected from welfare cuts, by the infamous triple-lock, while other pensioner benefits have been protected too. Furthermore, the massive rise in the pensions deficit (notably due to low long term interest rates) has been primarily responsible for driving a wedge between productivity growth and pay growth. Companies have had to pay into their pension funds, so that people working today are not benefitting from rising productivity.

Only in one respect are pensioners losing out, that is in terms of very low savings rates, while mortgage holders, who tend to be workers from generations after the baby boomers, have done very well. Nevertheless, overall the baby boomers have done exceedingly well.

It is time that government policy looks at rectifyting this siuation. This includes reducing pensioners benefits,  increasing inheritance tax, and raising housing supply at a more rapid rate.

A shift from monetary to fiscal stimulus a sensible one economically and politically

PM May's speech at the annual Tory party conference is being viewed as a massive change in policy direction. In a populist speech, in some ways, she talked about a need for greater fairness, to help those, the poorest that have been most affected by austerity. As well as talking about greater intervention to attend to market failures, she signalled changes in economic policy to, if you like, a greater emphasis on Keynesian policies.

Clearly her speech made sense from a political viewpoint. May is laying claim to the centre ground of politics which has been vacated by the Labour party. Labour continues to shift to the hard left, and under an unelectable leader does its best to make sure it is the case it will not be elected. Corbyn has refused to make any attempts to unify the parliamentary party with his latest reshuffle electing only his very closest allies, which is likely to lead to further infighting. Corbyn also refuses to acknowledge that the levels of  immigration seen is a problem, a key issue for many traditional working class supporters. But at the same time, May's speech also tried to appeal to UKIP supporters by emphasising the importance of control of borders and by adopting about the only non-Brexit UKIP policy - namely allowing new grammar schools. UKIP continues to implode struggling with finding  a raisin d'etre and a new leader to follow the highly successful Nigel Farage. But what I would say is that Theresa May should be judged not by what she says but what she does. Many new administrations start off with such sentiments of fairness but fail to follow through not least because of events as well as other priorities. This is not to say she is not committed to making a fairer society.

A shift from monetary stimulus to fiscal stimulus makes sense from both a fairness and macroeconomic point of view. When the coalition government came to power in 2010, it inherited a massive structural budget deficit partly due to the global financial crisis but largely reflecting years of irresponsible spending from the previous Labour administration. The government was left with little choice but to cut spending and raise taxes. This resulted in a greatly reduced budget deficit albeit that debt continues to accumulate and targets to balance the budget have been missed.

At the same time, monetary policy was eased. And in common with most other advanced countries we have experienced ultra low interest rates. Base rate was cut to a record low 0.5% over seven years ago and further to 0.25% in August. Quantitative easing (QE) has seen some £375bn of gilts purchased, with a further programme announced in August of an additional £60bn of gilts and £10bn of corporate bonds in response to the Brexit vote and largely unfounded fears that the economy would be plunged into recession.

Now there is no doubt that monetary policy has been overburdened and there have been many side effects from the semi-permanent monetary stimulus. One of these side effects has been the distributional consequences. Economic policy has favoured holders of fixed assets and mortgage holders as against savers and potentially pension holders. A Bank of England study found for example that QE did boost growth but that the benefits tended to go to the richest 5% who own 40% of assets. And of course spending cuts have impacted on the poorer too.

It is not good that savers cannot get a decent return as it disincentivises, especially people to do so for retirement, increasing the prospect that people will rely on the government and increase  their own already high household debt. Similarly long-term investors like pension funds and insurance companies can no longer earn a real rate of return threatening their solvency. It is also not good if the burden of providing a pension falls on the government when we have an ageing population. Corporate pension fund deficits reached a record high at £459bn at the end of August due to plunging bond yields which have also raised fears that firms might cut their investment plans. Although as has been pointed out by our UK economists at Oxford Economics, assets held by defined benefit schemes have actually increased by £135bn in the four months to August. Bank's profitability have been badly impacted by low interest rates too, affecting their ability to lend.. And while most people would not be sad about bank'statement plight, it could also contribute for the need for expensive bailouts given the pivotal role that banks do play in the economy. As it is not good for savers, low interest rates are great for borrowers. However again we are storing up problems for the future in building up such debt. If and when interest rates rise again, we are likely to see many distressed borrowers given the highly leveraged position of the household sector. Finally, ultra low interest rates lead to the mispricing  of financial markets  pushing up equity and bond prices. In addition they lead to a misallocation of capital  with a rash of low-return capital projects.

There is no doubt that monetary policy  has been asked to do too much and that it has reached the end of its effectiveness. Thus for example, negative interest rates will not work in the UK. But with a greatly reduced budget deficit and long term rates close to zero, this is an ideal time to ease fiscal policy a little to meet the uncertainty regarding the medium term impact of Brexit.  The government has built up a lot of policy credibility so can afford some slippage towards its aim of balancing the budget. It certainly makes little sense to remail committed to reach budget balance by 2020 at such a time. Increased spending on infrastructure can boost growth and boost the supply side of the economy without "crowding out" the private sector given the low cost of funding. But it will still be important to not waste money on cost ineffective and spurious projects which offer political rather than any economic returns. It will be important to identify "shovel ready" projects. We shall have to wait  until the Autumn Statement on 23 November to see what exactly the Chancellor does to reset fiscal policy, but there was speculation already yesterday of the re-introduction of government backed high interest fixed-term bonds (and not just for the over 65s) which could be a good move.

From the impact of Brexit to the prospect of a European Banking Crisis

Well it is becoming increasingly clear that the initial impact of Brexit or more strictly the announcement of a Brexit will not bring forth recession. This is indeed what I said in my blog of 14 July when it was very much a minority view. Forecasts have all been revised up by various institutions like the OECD and the IMF and by international banks to around the GDP growth numbers that I suggested back in the gloom of July, namely 1.75% for this year and 1% next year - and if anything I would say these are now on the Conservative side. Thus nearly all major indicators are doing well including retail sales and consumer confidence, house prices, services sector output, and business confidence. In addition financial market variables have generally done well, with even sterling recovering somewhat.

So why were the forecasts so gloomy and clearly wrong? Well I think there are four reasons. Firstly the economic data underestimated the strength of the economy going into the referendum. For example, GDP in Q2 is now thought to have risen by 0.7% on the quarter well above initial estimates. Secondly it was due to the politicisation of key institutions including the IMF (see blog 29 July) and more obviously the UK Treasury and Bank of England. Thirdly, is reflects the state of macroeconomics and the herd instinct of many economic commentators (wait for a future blog here) and finally it is fair to say that the Bank of England took prompt and appropriate action in loosening monetary policy via a number of methods.

But of course I am not naive to believe it is all going to be rosy. In the medium-term there will be adverse consequences on what will be difficult and protracted negotiations with an EU which is standing firm on its unwillingness to compromise on the trade-off between access to the single market and control of borders, despite the prospect of the EU being adversely affected too. However as we seemingly move towards a hard Brexit again  as previously predicted, it is hoped that these negotiations can be completed more quickly enabling us to travel to the point where we can free trade with the rest of the world and hopefully with the EU too, via being an independent member of the World Trade Organisation. I continue to have a very positive outlook for the UK in the long term, perhaps as part of a Commonwealth free trade union with Australia, Canada and New Zealand leading the way. These are countries we have so much more in common with than the EU.

Finally I would also like to mention the banking problems in Italy and now Germany. While not wanting to minimise the impact of Brexit on the UK and on the Eurozone too,  the biggest immediate fear is that of a European Banking Crisis.  The problems are hardly surprising in that they largely reflect the poor health of the Euro Zone and the flaws of European monetary union without fiscal and political union. At the moment the problems at Deutsche are unlikely to be Europe's Lehmann moment and a boost its capital should help. I am more concerned about the solvency of Italian banks and the not unrelated constitutional referendum in early December which will in effect be another big test for the EU and could see the Italian government fall.

What form of Brexit becomes a little clearer.

After correctly taking her time and postponing triggering Article 50 until the government's negotiating position is settled (still expected in early 2017 despite pressures from some to wait until September after French and German elections), PM May is beginning to make some decisions and decide what form Brexit will likely take.

Mrs May has correctly ruled out another general election. She could have capitalised on her party's huge poll lead over a warring and inward looking Labour party. But people have had enough of elections and it would only add to uncertainty in the unlikely event of a Labour election. But above all there is no rationale or precedent for a new leader to go to the country. We elect a party to government in this country not a PM. Similarly, a full vote on Brexit for parliament has been ruled out quite correctly as the people have already spoken, although it will be given "a say" on the process. Furthermore,  a second referendum has also been ruled out, since if the terms of exit were defeated, this at best would increase the uncertainty, but most likely leave the country in limbo.

And above all, Mrs May has made clear that the government would pursue some form of hard Brexit. And that there would be no attempts to "stay in the EU by the backdoor". A hard Brexit will be much easier to negotiate from both a political and probably a technical perspective too.  As the people voted for major control of borders and to take back their sovereignty, retaining membership of the single market will very likely be a non-starter. Thus the so-called Norway option is ruled out (although there may be a role in the interim period for this option).

Furthermore, it will be a bespoke one says Mrs May. So talk of an "off the shelf" option like the Swiss or Canada one has been rejected. Even so one might expect that the deal pursued would be close to a Canada plus deal. Under this option we would secure a free trade agreement with the EU in whatever sectors are covered by the agreement. Ideally this would cover services as well as manufacturing and agriculture. The key issue here however, is that the EU may not be willing to extend any agreement to services and above all financial services (despite the obvious benefit for consumers throughout the EU) given the UK has a large surplus and comparative advantage with the EU, so it would harm EU producers.

If the EU refused to extend to services, there is still plenty to be optimistic about in that we can revert to trading with the EU according to World Trade Organisation rules. Though we would be subject to the EU''s Common External Tariff (and to non-tariff barriers), we would cut out all the uncertainty of negotiations with the EU as well as maintain full control of borders and maintain sovereignty as promised to the electorate.  But from an economic perspective we would be in a position to negotiate free trade deals with countries throughout the world much more quickly. For example, the infamous Transatlantic Trade and Investment Partnership (TTIP) free trade deal between US and EU is very unlikely to be concluded successfully ( which I hope to explain why in a future blog). The UK is much better placed to succeed in talks with the US and more speedily, contrary to the intervention of President Obama in the run up to the referendum. We could also negotiate trade deals with other countries, most notably Australia, NZ,  Canada and Singapore with their shared values, but also other bigger countries like China and India again more easily.

Under hard Brexit we would be free to boost the supply side of the economy further, by lowering taxes, and reducing EU related regulations - boosting product and labour market flexibility. Our international competitiveness and growth prospects would be raised. In recent days the EU has shown it's interventionist, collectivist, centralising, protectionist and high tax tendencies through its failure of the TTIP and it's war on tax competition and Ireland. The UK is right to go it alone, particularly as it also plans to deepen European integration at the expense of non-euro zone countries. But the UK must also make sure that UK growth benefits everyone. This means getting rid of tax loopholes, perhaps as a complete overhaul and simplification of the tax system, clamping down on certain corporate behaviour, but also social justice.

What type of Brexit will we get?

In my last blog, I discussed the daunting administrative and political challenges in exiting an organisation we have been a member for 43 years and of negotiating a new relationship with the EU and the rest of the world. When to trigger Article 50 will be a critical issue given the political timetable of elections in Germany and France, of European Parliamentary elections and finally UK elections in May 2020. This is particularly so when Article 50 gives us just two years from when it is triggered which is not a lot of time when you are dealing with 27 countries and given how long it takes to negotiate trade deals. Thus one likely option is an interim deal before a final agreement.

One of the principal options the UK could go down is the so-called Norway option. This involves membership of the European Economic Area (EEA). This gives full access to the single market but we would not need to  participate in a number of  EU  policies including agricultural, fisheries, security, foreign, and justice. We could also negotiate trade deals with non-EU countries. However, I think this is exceedingly unlikely to be the favoured route. It would require free movement of labour which is clearly unacceptable to the majority of the population who voted to leave. Furthermore, it would also require us to be subject to EU regulations. Given the importance of sovereignty to much of the population and the Tory right, again this would be a red line that could not be negotiated on. Furthermore, the City has also said it does not like the idea of financial regulation being imposed over which it has no influence over. Finally, we would still have to make contributions to the EU budget, which could even exceed what we pay now, without any rebate being on offer.

More appetising would be some sort of Swiss-style deal.  Switzerland has access to the single market without some of the burdens of membership. Even so it has involved some contributions to the EU budget and some acceptance of regulations. But the main downside has been acceptance of free movement of labour. In February 2014 Switzerland voted narrowly for quotas on EU immigration.  This has put existing bilateral deals under threat. Yet there is talk of introducing an"emergency brake" procedure to halt immigration if the country becomes overwhelmed. Similarly there is now talk of an emergency brake lasting up to 7 years for the UK. This option is possible for the UK and given its greater leverage than Switzerland they would hope to negotiate a more favourable package although it could work against us. This is now seen as the favoured option for the City, an industry critical for the wealth of this country and potentially badly impacted from lack of access to the single market. It hopes to negotiate trade deals in individual sectors and secure asort of Swiss plus deal. While a number of EU leaders have expressed a willingness to secure a special deal,  success will not be easy given not only the complexities but also that many EU players want to penalise the UK.

The final option I wish to mention is the World Trade Organisation (WTO) option. This is much favoured by the Brexiteers as it would not only enable us to "get back" our national sovereignty including  control of borders and regulation but also have the freedom to agree trade deals with third countries and avoid contributions to the EU budget.  Here the UK  would rely on WTO rules for access to European markets but would be subject to the EU's external tariffs as well as non-tariff barriers. But this will not be easy either and take a number of years to achieve.

Given that the UK and EU's likely negotiating positions will start very far apart, this is perhaps still the most likely option. However I personally feel that the Swiss plus option will in the end be the path that we will go down and achieve, albeit over many years of painful negotiations.

What type of Brexit will we get?

In my last blog, I discussed the daunting administrative and political challenges in exiting an organisation we have been a member for 43 years and of negotiating a new relationship with the EU and the rest of the world. When to trigger Article 50 will be a critical issue given the political timetable of elections in Germany and France, of European Parliamentary elections and finally UK elections in May 2020. This is particularly so when Article 50 gives us just two years from when it is triggered which is not a lot of time when you are dealing with 27 countries and given how long it takes to negotiate trade deals. Thus one likely option is an interim deal before a final agreement.

One of the principal options the UK could go down is the so-called Norway option. This involves membership of the European Economic Area (EEA). This gives full access to the single market but we do not need to  participate in a number of  EU  policies including agricultural, fisheries, security, foreign, and justice. We can also negotiate trade deals with non-EU countries. However, I think this is exceedingly unlikely to be our favoured route. It would require free movement of labour which is clearly unacceptable to the majority of the population who voted to leave. Furthermore, it would also require us to be subject to EU regulations. Given the importance of sovereignty to much of the population and the Tory right, again this would be red line that could not be negotiated on. Furthermore, the City has also said it does not like the idea of financial regulation being imposed over which it has no influence over. Finally, we would still have to make contributions to the EU budget, which could even exceed what we pay now, without any rebate being on offer.

More appetising would be some sort of Swiss-style deal.  Switzerland has access to the single market without some of the burdens of membership. Even so it has involved some contributions to the EU budget and some acceptance of regulations. But the main downside has been acceptance of free movement of labour. In February 2014 Switzerland voted narrowly for quotas on EU immigration.  This has put existing bilateral deals under threat. Yet there is talk of introducing an"emergency brake" procedure to halt immigration if the country becomes overwhelmed. Similarly there is now talk of an emergency brake lasting up to 7 years for the UK. This option is possible for the UK and given its greater leverage than Switzerland they would hope to negotiate a more favourable package although this would not necessarily be so. This is now seen as the favoured option for the City, an industry critical for the wealth of this country and potentially badly impacted from lack of access to the single market. It hopes to negotiate trade deals in individual sectors and secure a sort of Swiss plus deal. While a number of EU leaders have expressed a willingness to secure a special deal,  success will not be easy given not only the complexities but also that many EU players want to penalise the UK.

The final option I wish to mention is the World Trade Organisation (WTO) option. This is much favoured by the Brexiteers as it would not only enable us to "get back" our national sovereignty including  control of borders and regulation but also have the freedom to agree trade deals with third countries and avoid contributions to the EU budget.  Here the UK  would rely on WTO rules for access to European markets but would be subject to the EU's external tariffs as well as non-tariff barriers. But this will not be easy either and take a number of years to achieve.

Given that the UK and EU's likely negotiating positions will start very far apart, this is perhaps still the most likely option. However I personally  feel that the Swiss plus option will in the end be the path that we will go down and achieve albeit over many years of painful negotiations.

What type of Brexit will we get?

In my last blog, I discussed the daunting administrative and political challenges in exiting an organisation we have been a member for 43 years and of negotiating a new relationship with the EU and the rest of the world. When to trigger Article 50 will be a critical issue given the political timetable of elections in Germany and France, of European Parliamentary elections and finally UK elections in May 2020. This is particularly so when Article 50 gives us just two years from when it is triggered which is not a lot of time when you are dealing with 27 countries and given how long it takes to negotiate trade deals. Thus one likely option is an interim deal before a final agreement.

One of the principal options the UK could go down is the so-called Norway option. This involves membership of the European Economic Area (EEA). This gives full access to the single market but we do not need to participate in a number of  EU  policies including agricultural, fisheries, security, foreign, and justice. We can also negotiate trade deals with non-EU countries. However, I think this is exceedingly unlikely to be our favoured route. It would require free movement of labour which is clearly unacceptable to the majority of the population who voted to leave. Furthermore, it would also require us to be subject to EU regulations. Given the importance of sovereignty to much of the population and the Tory right, again this would be red line that could not be negotiated on. Furthermore, the City has also said it does not like the idea of financial regulation being imposed which it has no influence over. Finally, we would still have to make contributions to the EU budget, which could even exceed what we pay now, without any rebate being on offer.

More appetising would be some sort of Swiss-style deal.  Switzerland has access to the single market without some of the burdens of membership. Even so it has involved some contributions to the EU budget and some acceptance of regulations. But the main downside has been acceptance of free movement of labour. In February 2014 Switzerland voted narrowly for quotas on EU immigration.  This has put existing bilateral deals under threat. Yet there is talk of introducing an"emergency brake" procedure to halt immigration if the country becomes overwhelmed. Similarly there is now talk of an emergency brake lasting up to 7 years for the UK. This option is possible for the UK and given its greater leverage than Switzerland they would hope to negotiate a more favourable package, although this is hardly guaranteed. This is now seen as the favoured option for the City, an industry critical for the wealth of this country and potentially badly impacted from lack of access to the single market. It hopes to negotiate trade deals in individual sectors and secure a sort of Swiss plus deal. While a number of EU leaders have expressed a willingness to secure a special deal,  success will not be easy given not only the complexities but also that many EU players want to penalise the UK.

The final option I wish to mention is the World Trade Organisation (WTO) option. This is much favoured by the Brexiteers as it would not only enable us to "get back" our national sovereignty including  control of borders and regulation but also have the freedom to agree trade deals with third countries and no contributions to the EU budget.  Here the UK  would rely on WTO rules for access to European markets but would be subject to the EU's external tariffs as well as non-tariff barriers. But this will not be easy either and take a number of years to achieve.

Given that the UK and EU's likely negotiating positions will start very far apart, this is perhaps still the most likely option. However I personally  feel that the Swiss plus option will in the end be the path that we will go down and achieve albeit over many years of painful negotiations.

The complexity of implementing Brexit

One of the main themes of my blogs will be Brexit. I have largely avoided focusing on this so far. We all know in the words of PM May that "Brexit means Brexit" is her government's slogan. Yet in reality we dot not know what Brexit will be. There are so many options to consider with the trade-off between access to the single market and the control of the borders at the root of most of them. Certainly a key decision for the government will be to set out its strategy including its red lines. I shall return to these options in future blogs.

What is becoming clearer is the complexity of these negotiations. Not only will there need to be talks covering the UK's divorce from the EU, but there will have to be talks on securing a free-trade agreement with the EU, one likely for interim measures, another with the World Trade Organisation to regain full membership, some on securing free trade deals with non-EU countries and even more talks with the EU on foreign and defence policy etc.

None of these talks will be easy, yet the civil service and the three key departments of the Foreign Office, Brexit and international trade are ill-prepared. There is now talk that article 50 of the Lisbon Treaty, which gives us just 2 years to sort everything out before leaving the EU, may not be triggered until  late 2017, with additional problems of the French elections next May and German elections next September to be considered. Yet this would push back Brexit to late 2019 dangerously close to our own general elections in May 2020. Furthermore, such a long period of uncertainty will be damaging economically.

Thus it is imperative the new government not only  makes clear it's negotiating situation, but unifies it's own party and the nation as a whole - neither of which will be easy. It must emphasise business as usual, reassuring different sectors of the economy such as farmers and science that they will not lose out, and that EU nationals can still work here. The country should take maximum advantage of a more competitive currency and loosen fiscal policy to boost aggregate demand in these uncertain times.

First hard data for UK economy post-Brexit

This week is being seen as an important week by many in the markets for evidence of the impact of the Brexit vote on the UK economy. We have the first hard data for July for inflation, for unemployment, for retail sales and for the public finances.

Sterling has fallen further against a background of a package of monetary policy easing measures and the disappointment of the latest gilt auction, reinforcing the prospect of further monetary policy easing, with Base rates likely to be reduced to 0.1% from their present 0.25% in the coming months, and raising the likelihood of fiscal policy measures in the forthcoming Autumn Statement. Certainly prospects are that sterling will remain weak against this background and little expectation of clarity regarding the UK's Brexit negotiating position.

But I don't believe in reality that there will be much light shed on the initial impact of the Brexit vote on the UK economy this week. The plunge in the pound is unlikely to have fed through in July's CPI numbers much, with base effects and a sharp rise in petrol prices predominating. The excellent UK economists at Oxford Economics expect the inflation rate to remain at 0.5% y/y. I personally believe the impact further out will be more modest than consensus. Unemployment is a lagging indicator so expect the rate to remain at its near 11 year low of 4.9% or even fall back slightly.  Perhaps the most eagerly expected release will be retail sales, given the importance of consumer spending for driving UK growth. Key survey data has given us conflicting stories. The official data has been especially volatile of late and I would anticipate we will not be able to conclude anything much because of the noise.

The plunge in sterling should be very positive for the UK economy as we aim to boost exports particularly in light of poor current account data. Anecdotal data shows a very strong upturn in tourism from foreigners taking advantage of a cheap pound and increased staycation.

The feelgood factor from our sporting successes continues too. The UK amazingly lies second in the Olympic medals table equal to the combined total of Germany and France, and ahead of China. It could even be more successful than in London 2012! The success of the National Lottery, introduced by the Major government, has contributed most of the £350m into UK sport for the Olympics and Paralympics. Money is focused on those sports where we are successful. But the fact is that the number of sports we are successful in is increasing. We have also done well in swimming, diving and gymnastics this time as well as in rowing, sailing, cycling and equestrian where we  lead the world. The National Lottery may be a regressive tax in effect but this is not a reason to abolish it.

Hinkley. Should we say no?

Last year, the Conservatve government under PM Cameron and Chancellor Osborne, announced a series of economic initiatives with China which was said to have started a "golden era" between the two countries. But new PM May's government, surprised everyone recently when they put on hold final approval for a new nuclear power station at Hinkley Point, in South-West England, so they could review it. The new French-built power station, was set to receive some US8bn in Chinese investment for the project.

It has been said that PM May is reviewing it principally because of  security concerns with China's role in the project. That this is the reason, is based on a blog post from her chief of staff and comments from former government (but Liberal-Democrat) Vince Cable. In any case such fears are probably overblown given that security checks are rigorous, that China's role is purely on the money side and that any attempt of China to compromise our national security would damage China's reputation and ability to work on infrastructure investments in the West again.

In any case, there are far more important reasons to cancel this project. John Maynard Keynes, the greatest economist of the 20th century, is purported to have said, "that when the facts change, I change my mind. What do you do sir?" Well the facts have changed since the original decision to back the project was made in 2010.  As the Economist magazine reported on August 6th the project now looks "extraordinarily bad value for money". The UK has promised to pay some £92.50 per megawatt hour for Hinkley's output compared with wholesale prices of some £40 today, and perhaps lower in 2025 when it due to open. Furthermore we have promised to pay this for 35 years! Yet the government has reduced the forecast cost of producing electricity from various renewables in 2025 by a third for onshore wind and by nearly two-thirds for solar power - both well below the £92. They will only come down further after 2025. Renewables are the future, and big new nuclear power stations  like Hinkley (which would fulfil some 7% of our needs) have no real future and certainly with such price guarantees. In the short-run we will need more electricity, but these should be from gas-powered plants, that can be built quickly, run cheaply and turned on and off quickly to offset fluctuations in renewable supply.

What of the relationship with China?  Well the Chinese are clearly not happy. And it is not great timing, when we have a Brexit to implement, when we are emphasising trade deals and being open to the rest of the world and when our economic relationship was already lagging Germany and France's relationship with the Middle Kingdom. However, it should be made clear that the decision to not go ahead with Hinkley is purely a financial one. There may be a short-term impact on the relationship but I am confident it can flourish. There is a lot more than nuclear power out there. However, there is a final point. At this time of a possible economic downturn and virtually 0% gilt yields, there is no reason why the UK cannot fund far more infrastructural projects itself!

How is new UK PM May's policies evolving?

Theresa May has come to power being dealt a difficult and constraining hand in terms of the Brexit vote. But most indications are that she was at best a reluctant Remainer and that she believes in controls on immigration and looser ties with Europe anyway.

Her brand of Consevatism is very much pragmatic, but like Cameron, also modernising and certainly not idealistic like Mrs Thatcher who she has superficially been compared with. Though she does have two key advisers that provide idealistic input to her thinking now and when she was at the Home Office. Her stated aim is to help those that have been left behind by the UK economy's success which has partly fed on globalisation. They are mainly the white working classes, particularly in the North. There is a clear shift to the left which will do the party no harm electorally. Not only is the main opposition, Labour party, sadly for democracy, tearing itself apart, but it is shifting sharply left with policies even to the left of previous leader Ed Miliband who was soundly beaten at the previous general election. And current leader Corbyn, unlikely to be beaten by challenger Owen Smith, is seen as even more incompetent than Miliband. Indeed polls already give the Conservatives a massive 14% point lead over Labour. Furthermore the Liberal Democrats will take a generation to recover from electoral defeat, and UKIP having achieved their main objective of Brexit are squabbling over some new policies without their highly effective leader Nigel Farage, and could become sidelined like the Liberals..

So as I see it, the key changes will be greater emphasis for industrial policy, hence a new department and a commitment to rein in foreign takeovers. She dispensed with a department dedicated to climate change, reflecting reduced emphasis there. There will be a greater emphasis on reducing inequalities. so do not expect cuts in direct taxation especially corporate and income taxes but increases in infrastructure spending and generally more state intervention. Also controls on corporate pay and an emphasis on multinationals paying their "fair share" of taxes.  Expect to see less emphasis on globalisation with not only cooler ties with Europe, but also China (look at Hinkley power station being put on hold) and even the US. Commonwealth ties will likely be revived. Finally expect tough measures against crime and new grammar schools being permitted.

However, I have some concerns. Firstly an industrial policy or strategy smacks of the failed policies of  the 60s and 70s. More of this another time. .Secondly as I mentioned above the UK's rapid growth rate in comparison to its European peers over the last 30 years has been due to taking full advantage globalisation, open to foreign direct investment, to immigration, to flexible labour markets, to free trade, to low taxation and so on. But at this difficult time we should be careful not to abandon these things or to permanently increase state spending when we are left with a massive government debt burden following the excesses of previous Labour administrations and the impact of the global financial crisis. More equality could mean much less wealth for every one, lower growth and ever rising government debt.