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May sees election opportunity in Brexit economy's sweet spot

Wednesday, April 19, 2017 - 10:45

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Ms Theresa May's unexpected gamble on an early national election on June 8 is aimed at strengthening her hand going into the talks on leaving the European Union. With a wide lead over the opposition in polls, she can exploit the economy's resilience before voters really start to feel the pinch from faster inflation.

[LONDON] The UK economy is in a sweet spot and Theresa May's not letting it go to waste.

The lowest unemployment in more than a decade and forecast-defying growth give the UK prime minister a favourable backdrop for the snap vote she called on Tuesday. That positive environment was reinforced just hours after her announcement when the International Monetary Fund published a huge upgrade to Britain's outlook.

Ms May's unexpected gamble on an early national election on June 8 is aimed at strengthening her hand going into the talks on leaving the European Union. With a wide lead over the opposition in polls, moving now also means she can exploit the economy's resilience before voters really start to feel the pinch from faster inflation, or if the reality of Brexit begins to hurt investment and hiring.

"If you were going to pick any time to do it, now would be the best," said Paul Hollingsworth, an economist at Capital Economics in London. "The real squeeze on household incomes is probably going to come later."

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The pound had its biggest gain in three months on Tuesday on news of the UK election, which will come between French and German national votes in what's becoming an increasingly busy political year across Europe.

Ms May's timing coincides with what Bank of England Deputy Governor Ben Broadbent has called a "sweet spot" for exporters, who are benefiting from a weaker pound while their EU trading arrangements - with full access to the single market - remain in place.

Her calculation may be supported by the better-than-expected growth since the referendum in June. The outperformance contrasts starkly to the bleak predictions about leaving the bloc from former Chancellor of the Exchequer George Osborne a year ago this week.

But one area where Brexit has started to bite has been inflation, with sterling's decline pushing the pace of price increases to the fastest in more than three years. Coupled with lackluster wage growth, that's eating into spending power, with real earnings almost stagnant.

"From an economic point of view, it certainly looks to make the most sense for the Conservative government to hold a general election as soon as possible," said Howard Archer, an economist at IHS Markit in London. "The government will hardly be oblivious to the fact that life is likely to get more difficult economically for voters over the coming months."

The bleaker outlook could be an opening for the opposition Labour Party during the election campaign. While the economy has enjoyed four years of uninterrupted expansion, leader Jeremy Corbyn has argued that the spoils haven't been evenly shared and, in his response to the election call, said the government has "delivered falling living standards". Despite the drag from inflation, and the potential weight of Brexit on companies' investment plans, the economy still has momentum.

While some economists anticipate that weaker domestic demand means UK growth will slow this year, consensus in Bloomberg's latest survey is for 1.8 per cent growth, matching 2016's pace. The IMF sees expansion of 2 per cent, almost double the rate it predicted six months ago.

There's also a chance that, with unemployment below 5 per cent, the pickup in inflation is at least partly matched by wage growth, softening the hit on consumers.

The election is unlikely to affect the outlook for Bank of England interest rates, according to Rob Wood, chief UK economist at Bank of America Merrill Lynch.

While one policy maker to vote for an interest-rate increase last month, the majority argue the current stance should remain for now. The additional uncertainty of the election may strengthen their arguments against any change in the near term. The Monetary Policy Committee will announce its next decision on May 11, when it will also publish new economic projections.

"A rate increase this side of June 8 was extremely unlikely anyway," Mr Wood said. "There's going to be some turbulence to come. It's hard to know what the general election means for the economic outlook. Now is not the time for the BOE to be hiking."

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