Outlook 2017: Currency, inflation and labour cost risks

The UK economy, which had been growing consistently, has been shaken by a major dose of uncertainty.

Nobody knows how well the UK will fare from Brexit in the long term, but in the short term, some companies have become reticent to reinvest in the UK, suggesting reduced growth in future years, says Andersons research economist Graham Redman.

However, uncertainty over Brexit has weakened sterling substantially, allowing those who sell their goods to overseas buyers, including the farming sector, to reap the rewards, Mr Redman says.

See also: Weak pound could raise farm profitability by 15% in 2017

“The exchange rate between the euro and the pound is the biggest single determinant of UK farm profitability – a weak pound is great news.

“But currency will remain highly sensitive to political announcements and decisions – it will not take note of the performance of UK farming.”

UK stockmarkets and other assets have also risen on the back of currency effects, with FTSE100 companies benefiting from their global footprint. Most sales are made to overseas markets and paid for in dollars or euros, says Mr Redman.

Recent price rises are the first signs of rising inflation. In the absence of other unforeseen changes, for example to supply and demand, weakening currency pushes prices up, he says.

Inflation

“We have also seen UK base rates fall from previously historic lows to an even lower level in 2016, and significant quantitative easing [the Bank of England putting liquidity into the domestic economy] – both of which are inflationary.”

Furthermore, levels of unemployment are at a 10-year low, despite immigration. This is a further inflationary factor, as employers have to pay more to secure the right skills.

“We would expect increased input cost inflation in early 2017, then wage inflation a few months later.”

Inflation is unlikely to balloon, he adds. Several deflationary factors are at play, such as UK debt, the growth of the internet and globalisation, all of which have kept consumer prices low.

But Brexit is the main factor, says Mr Redman. “Businesses are eager to keep customers, so are not raising prices.

“Firms are also possibly looking to consolidate their financial position, so are probably more hesitant about entrepreneurial risk-taking and growth.”

They are also uncertain about access to European markets after 2019, he adds. “But once they visualise a route for their firms in Brexit, these brakes might be released and inflation could increase, perhaps significantly.”

Beyond the inflationary pressures, it is difficult to project how the UK economy is going to develop in 2017 with any certainty, says Mr Redman. As much, if not more, will depend on political negotiations as it does on monetary or fiscal policy.

“The short-term ‘Brexit boost’ from sterling devaluation has been welcome for farming and some other sectors of the economy,” he says.

“But the vote was a ‘forever decision’ – the long-term effects will be more important.”

Policy

Until Brexit formally happens, support from the Common Agricultural Policy (CAP) remains in place and all the rules of the CAP still apply.

While UK farmers will continue to receive the basic payment for at least 2017 and 2018, what happens thereafter is less certain, says Andersons research consultant Caroline Ingamells.

“Even if we have exited the EU in early 2019, it is doubtful that Defra and the devolved administrations would have time to work up a significantly different agricultural policy.

“We would expect a system similar to the BPS to be continued for 2019, and probably 2020 as well.”

There is also more certainty for those trading Basic Payment Scheme entitlements, says Mrs Ingamells. “It looks as if there will be at least two years, probably three, and possibly even more to claim on entitlements purchased in 2017.”

The Treasury also created more certainty about rural development Pillar 2 funding, confirming in October that all structural and investment fund projects, including agri-environment schemes signed for before the UK leaves the EU will be honoured. The funding guarantee also applies to the devolved administrations.

“However, it is possible there will be fewer contracts available over the next two years,” says Mrs Ingamells.