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Podcast transcript

Economic outlook podcast

Host: So it's September the 16th 2019 and this is the latest edition of Barclays Corporate Insights. Hello my name's Rob Ratcliff and I felt the need to preface this episode with the date we're recording. Because if a week is a long time in politics then it's an age in the current era of Brexit. As we sit down to record this afternoon the world's biggest oil processing plant in Saudi Arabia is on fire sending the price of oil up by as much as 10 percent. And our new prime minister is in Luxembourg meeting the president of the European Commission and England's men have drawn the Ashes Test series with Australia.

But Australia retain the Ashes. I almost don't know where to start with all of this. So to help us make sense of all of this I'm joined as ever by Henk Potts, Director of Investment Strategy for Barclays Private Bank.

Henk Potts: Nice to be with you.

Host: And also by Sophie Wheeler-Traherne from our Government Relations team who will try and unlock some of the political context for us.

Sophie Wheeler-Traherne: Thank you for having me.

Host: Sophie I guess we'll start with you. When we last recorded this podcast I think back in June the Conservative leadership election was under way that feels like an absolute lifetime ago.

We always sort of knew who would probably win that contest of course become our prime minister. So can you try and give us sort of a whistle stop tour of Boris Johnson's first few months in office. Specifically I guess what's happened since the MPs have returned after the summer.

Sophie Wheeler-Traherne: Yeah absolutely it's been an extraordinary few weeks in British politics and as you say MPs returned from their summer recess at the beginning of September and not everything is gone to plan for our new Prime Minister Boris Johnson. He saw legislation go through the House of Commons that could essentially lead to a further extension of Article 50 so moving that Brexit date yet again. He had to fire over 20 Conservative MPs from the party including numerous former cabinet ministers and Winston Churchill's grandson and he tried and failed twice to get the votes he needed for an early general election to break the deadlock.

Just as a reminder he needs two thirds of employees to vote for that general election, that's 434, and he did not reach that target. And on Monday night last week we then saw Parliament prorogued just before 2:00 a.m. on Monday night and this means that the current parliamentary session has come to an end and MPs won't meet again until the State Opening of Parliament on the 14th of October which is marked by the Queen's Speech and you've probably also read that this prorogation is actually being challenged in the courts. And last week the Scottish courts rule ruled that the prorogation was unlawful.

They said that the true reason for prorogation was to stymie parliamentary scrutiny of the executive. Something denied obviously by the government. So there is a lot of attention on the Supreme Court this week who'll hear an appeal on behalf of the government against this ruling on the 17th of September with the judgement expected later this week. So a lot of focus on the Supreme Court in what could be another crucial week for the prime minister.

Host: So it's extraordinary times we're living in but I mean this bill seems quite straightforward to me. He's got to ask for an extension. So end of January 2020 Brexit, right?

Sophie Wheeler-Traherne: Yeah, so let's just look at what the bill does. And this was orchestrated by the remain alliance of MPs in Parliament and essentially it mandates the government on the 19th of October. So another key date there to seek an extension of Article 50 until 31st of January 2020 if the House of Commons has not yet explicitly approved a Brexit deal or given approval for a no deal. So that's what the bill does and this is now law and it would force Boris to do the thing which he promised he wouldn't do - extend the Brexit deadline beyond that Halloween date.

It's worth keeping an eye on what has been said since that bill was passed by the Prime Minister himself and senior cabinet ministers. Dominic Raab was on the radio this morning and he said that the legislation was deeply flawed and that they'd be looking carefully at it.

And remember the Prime Minister has said emphatically numerous times that he will not ask the EU for that extension. So lots of people in Westminster scratching their heads about what does this mean? Can he just ignore the legislation? Sort of cue lots of speculation about how he could get around it. What are the legal loopholes in the bill? Could the Prime Minister send a letter alongside the article 50 letter if he has to do this on the 19th essentially contradicting it and asking for it to be ignored? Could he ask an EU state to use their veto and block any request for an extension?

So lots of speculation about how he could get around this piece of legislation and of course I should say the other way he could avoid requesting the extension would be to try and get a deal with Brussels.

Host: Okay so Henk can I bring you in on that for a moment what do you think? Has Boris read Donald Trump's book 'The Art of the Deal'. Can he get a deal before October 31st?

Henk Potts: I'd imagine Prime Minister Johnson prefers something more in Latin rather than having to sully his mind with the idea of working out how real estate deals in the United States are completed, one would suspect. But there's no doubt negotiation is required if we are to see real progress in terms of negotiations with Europe and it still looks incredibly difficult, I have to say. The reality is there's limited progress if any progress appears to be made in terms of dealing with Europe around the Withdrawal Agreement. And then you also would suggest that things will continue to remain under pressure in some of these key areas of the negotiations particularly the Northern Ireland backstop which appears to be an insurmountable political problem.

So throw that into the mix and the deal still looks very difficult. So in some ways maybe you argue that an extension perhaps is inevitable certainly a general election appears some way in which we could try to remove some of the political impasse and if you take that to be the case there's still the possibility of Prime Minister Boris Johnson being returned, perhaps wtih a working majority still keeping a no deal Brexit on the table. So from an economic perspective there's still an awful lot for us to try and think about to understand how this problem is going to be resolved and the impact that's likely to have in terms of the economy.

Because while we still think no deal Brexit is in play and that has real risks around that we think it could throw the U.K. economy into a recession at the beginning of next year. We think actually it'd be quite a shallow recession but the UK economy contracting maybe by half of 1 percent. We think we'll see lower levels of business investment and household consumption continuing to weigh on the economy. Alongside that sterling would be expected to weaken quite dramatically which will result in a spike up in inflation. Unemployment is very low today but lower levels of business investment will filter through to higher levels of unemployment. So lots of risks around Brexit still for the UK economy.

Host: Sophie, what about that political context you know is there the will in the European Union to get a new deal done before the end of October?

Sophie Wheeler-Traherne: Yeah it's a really good point and I agree with what Henk said I mean that there's a lot of optimism on the British side. You know the Prime Minister said he believes passionately that he can get a deal before 31 October. He's met with Juncker today, 16 September, in Luxembourg. The statement after the meeting from the commission is less optimistic. They said essentially that the UK is yet to come forward with a solution to replace the Northern Ireland backstop that thorny issue which obviously dogged Theresa May's time as Prime Minister.

And also it was quite telling that they they said in their statement that the EU27 remain united. So they are still very much of the view that they've they've agreed this deal it's not open for negotiation and the backstop is not going to be just removed from the deal. So whilst there is optimism on the British side there's less so on the European side.

Host: I'd just like to take a bit of a half pivot away from Brexit if I can, we'll come back to the UK. Henk, can we get a bit of an update on what's happening with the US economy; have trade wars taken a back seat but potentially as real wars take more of a front seat?

Henk Potts: I don't think so. Listen the biggest risk to the global economy continues to be around trade wars they continue to be the biggest driver of short term market sentiment as well. And the US is impacted. We've heard so much around trade wars and about the impact it has on Asia and specifically China. The US I don't think is immune to trade wars. The reality is it's a bigger, it's a more diversified, it's a more insular, economy and also of course runs a trade deficit so there's less opportunity for other countries to impose tariffs. But the reality is slower global growth reduces demand for US products and services. Higher input costs inevitably will drive prices up for US consumers and maybe you step back and ask yourself who's been the biggest beneficiary of free trade over the course of the past three decades and it's probably the US consumer, the prices they've paid on the shelf. So it's certainly a price to be paid across the board.

So we continue to monitor that very closely. We think the reality is we're gonna have to live with higher tariffs for longer than was originally anticipated. The economic impact is more widespread more severe than originally projected and the disruption to businesses is likely to be more significant and that's part of the reason why we've been forced to shave - not slash - but shave some of our growth forecasts and expect a more aggressive policy response. You see that shining through in terms of the US economy.

Now we're not overly pessimistic about the US prospects. We don't see a near-term recession, in fact we still think US growth will be a pretty healthy two point two percent during the course of this year. But you see that trade backdrop that slowing growth backdrop shining through in terms of some of the recent data. Manufacturing exporters have been having a tougher time. Management teams have become more cautious and that's led to more subdued levels of business investment. Alongside that you start to see a waning effect of the stimulus program put in place under the Trump administration and therefore we'd expect growth to slow to around one point six percent as you look out to next year.

That's part of the reason why it feels like there's pressure on the Federal Reserve to try and react to that. So they've been cutting interest rates in an effort to support growth to cushion domestic economy from the weakness of international markets and of course in acknowledgement that US inflation expectations have weakened quite substantially so we'd expect probably a further cut later this year assuming that we get one of course during the course of this week.

Host: Okay. And some of the extraordinary sort of interventions that the president had been making in terms of the Fed and his opinions on rates, have they weighed at all on some of our forecasts or is the Fed immune to those kind of interventions.

Henk Potts: Well it's a difficult job for the Federal Reserve. I mean central banks like to make sure and prove to the markets that they're prepared to be independent. So despite the fact that President Trump has demanded that US rates go to zero or even lower than that one suspects we're not going to get to that point any time soon.

If anything maybe you could argue the Federal Reserve's been guilty of reacting to financial market conditions. We see a sell-off in U.S. equities for example it feels like there's more pressure on the Federal Reserve so they have found themselves in somewhat of a difficult position but I don't thing they've been reacting to that political pressure. They continue to look at the economy and what they've been suggesting is that these are mid-cycle adjustments to try and support the economic backdrop as opposed to a new cycle where they're envisaging a recession for example.

Host: And touching on recession the German economy the powerhouse of Europe as it were. Their economy contracted very slightly in the second quarter. A lot of commentators saying perhaps that the economy may slip into recession. What do we think around that? And does it matter?

Henk Potts: It does matter. The reality is that it's been a tough time for Europe and particularly for Germany. Germany's open and export orientated economies are particularly vulnerable to slowing global growth, to trade wars, to Brexit uncertainty and particularly in manufacturing: recession. You think about Germany as you say as this powerhouse of manufacturing but actually have gone through a tough time particularly the auto sector. The car industry has had to deal with weakening demand coming through from China. The impact of trade wars tougher new emission standards. So that's really been filtering through in terms of the German economy.

So we can expect to see further pressure right across the eurozone. So we think eurozone growth this year in total will be around 1.1% but slowing quite substantially, as you look out to next year where we expect growth of 0.6%. And that's part of the reason why we've heard so much from the European Central Bank in recent days they've restarted that quantitative easing program they've cut rates into deeper negative territory. The forward guidance says that they'll keep rates low or lower until the inflation number gets back towards the target level of close to but just below 2%.

But in some ways you feel the European Central Bank is saying, "listen we've done enough. We've almost run out of ammunition." But now it's back to those political leaders to try and commit to that reform agenda, try to commit to stimulus from a fiscal perspective to try and support growth. So pressure within Europe, authorities have been reacting to. Will it be enough to really turn things around remains a little bit more questionable.

Host: Okay turning back to the U.K. then, economic indicators have still been relatively strong. I think you know employment rate is stable at record rates 76.1%, wage growth is ahead of inflation but the GDP figures just again slipped into a negative growth in Q2. What's the picture here?

Henk Potts: Very volatile in terms of those growth numbers so we have the strong growth of course in Q1 growth of half of 1 percent, helped by stockpiling ahead of the original Brexit deadline date at the end of March. Then we saw an unwinding of those inventory levels during the course of the second quarter and that infringed upon growth. If you look at the July monthly figures actually showed you the UK economy performed reasonably well, we had growth of 0.3%. There's a strong performance from the dominant service sector. We even saw a pickup in terms of manufacturing and construction. So the numbers are a little bit volatile which suggests perhaps the UK economy won't be in that technical recession as you look towards the end of the third quarter.

The employment data has been really important. Part of the reason the UK has actually performed much better than was anticipated is because unemployment's been incredibly low. Unemployment in the UK is down at 3.8%, the lowest that we've seen since the early 1970s. Pay growth has been strong, accelerated to 3.8% during the course of July which is the strongest that we've seen in 11 years. Credit growth has been there; the weakness of the currency as well. But actually when you look underneath some of those headline particularly employment numbers you start see the early signs perhaps of that uncertainty perhaps from Brexit starting to filter through.

So if you look at job creation that slowed quite substantially. If you look at vacancy rates they're the lowest that we've seen since 2017. Average hourly workers have come down quite substantially. So there are some signs of some cracks even in the labour market despite what looks like glorious headline figures. I think we've got to be a little bit cautious and the reality is the closer we get to perhaps a no deal Brexit playing out the greater that pressure will be I think on the UK economy

Host: And Sophie that no deal Brexit or indeed a deal whatever should happen, I think one thing that's been made very clear as you sort of touched on already is that we're probably heading for a general election this side of Christmas, do you think? How is that going to play out?

Sophie Wheeler-Traherne: Yeah that is the big question in Westminster at the moment is the timing for that early general election. Ideally Downing Street would want a pre October 31 election while Labour want one after that Brexit deadline. And at the moment the power to call a general election appears to be very much in Jeremy Corbyn's hands. When MPs return for the Queen's Speech, it's Corbyn who has the ability to trigger a general election through a motion of no confidence in the prime minister which only needs a simple majority. So yes with everything going on it seems that we are on for a November-December election.

I believe this would be the first winter election since 1918 but it could also be pushed into the new year. So a lot of MPs wouldn't want it to be a sort of winter election, so it might be pushed into the spring and I would just say I mean although Boris seems to have had a tough couple of weeks. Things can change pretty quickly in politics and we could see things swing back in his favour over the next few weeks. And remember Number 10 have been laying the groundwork for a general election over the summer.

And they've also got a favourable narrative in terms of you know people versus the Parliament on Brexit. The party conference season will be crucial to this. Political parties are meeting for their annual conferences starting with the Lib Dems who are meeting at this moment in Bournemouth. They've had a good conference. They've unveiled a new Conservative MP another defector, sorry Lib Democrat MP a defector from the Conservatives. Then we have the Labour Party conference in Brighton. Imagine there'll be a lot of scrutiny of Corbyn's Brexit position along with a raft of domestic policy announcements and then the Conservatives the beginning in October again expect lots of announcements on things like policing and the NHS.

And just to touch on polling. And a big caveat with polling obviously they can't always be reliable. But the last one I saw had the conservatives around 33% Labour 24% Liberal Democrats 18 and the Brexit party at 13. So we did see a bit of a Boris bounce when he first became Prime Minister and he has managed to squeeze that Brexit party vote. But it is interesting that instead of the sort of the two traditional main parties dominating in the polls we are still seeing four parties battling it out in the polls.

And I mean it's also worth saying that in recent history general election campaigns haven't always run as expected. 2010 was supposed to be a clear Labor-Tory battle then in swept the Liberal Democrats. 2015 was not supposed to result in a majority for David Cameron and the Conservatives went into 2017 way ahead in the polls. So if anyone tries to predict the upcoming election treat that with their caution.

Host: Okay so happy Christmas then. The first winter election since 1918. Something to look forward to. I think that's all we've got time for. Thank you Sophie. Thank you Henk for all of your insights.

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