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U.K. Health Check: Growth, Deflation, and Brexit?

The UK economy is forecast to continue its solid growth over the next few years, with temporary deflation helping consumers while political events dominate the headlines.

Holly Cook: Hello and welcome to Morningstar.

Joining me today is Jose Garcia Zarate. He is a senior fund analyst and economist here at Morningstar, and we are going to talk about the U.K. economy.

Jose, thanks for joining me.

Jose Garcia Zarate: Thank you for inviting me.

Cook: The main news today is that the FTSE 100 has hit an all-time high, headlines are filled with positive stories. What's driving this?

Zarate: I guess that the key driver is the macro story, the fact that the U.K. economy has been doing well over the past few years, and it's actually expected to continue doing well in the next two to three years.

According to latest forecasts from the likes of the IMF or the European Commission, U.K. GDP growth is expected to average about 2.5% year-on-year in 2015-2016, which is pretty good. And it's all supported by a very resilient labor market, which is actually a very strong positive when you compare it to the situation in the eurozone, quite frankly.

Cook: That sort of economic forecast is pretty good going, really, but one of the newer concerns that's come on the radar recently is deflation. Is deflation necessarily a bad thing?

Zarate: Well, you don't have to take it from me, you just have to listen to the Bank of England governor, Mr. Carney, who says that deflation should be enjoyed in a way. Entrenched deflation is obviously an economic nightmare, but a temporary period of falling prices is actually a boost to consumer spending. So enjoy it while it lasts. I think that the Bank of England is not overly concerned about it, but it's highly likely that U.K. CPI will be in negative terrain for a few months this year.

Cook: From the consumer point of view, one of the most obvious ways they'll be feeling that potential deflation is at the petrol pump. Oil prices, the oil sector actually, has been one of the few sectors in the equity markets that's underperformed compared to all of the others. Should we be really concerned about that on an ongoing basis?

Zarate: Well, if you're Scottish, perhaps. Obviously, this is very important for the Scottish economy. And that's why you hear now voices from north of the border actually asking for subsidies, which makes a bit of a change to the narrative from a couple of years ago. So it's got its pluses and its minuses.

As I said earlier on, the big plus is the net benefit to the consumer. But obviously, anything that is related to the oil industry in Scotland, well, they're not going to be happy with the current situation.

Cook: Talking about Scotland makes me think of a referendum. The other referendum that's on our horizon is an EU referendum. How might that affect the U.K. economy or stock market?

Zarate: We don't even know whether the referendum is going to happen, but I think it is so much engrained in the public psyche that I think it's just a question of time. I went to find opinion polls about the referendum, because I was quite ready to see whether I needed to have my handkerchief ready to wave you all from the cliffs of Dover in case of 'Brexit' [British Exit]. And I was quite surprised in a way to find that the British population are fairly pragmatic when it comes to this. So contrary to mainstream media hype, if the polls actually are to be believed, Brexit is not the preferred option by any stretch of the imagination. In fact, if the U.K. were to successfully renegotiate its membership terms within the EU, the "stay" option in a referendum would very easily carry the day.

Cook: So no divorce just yet between the British and Spanish colleagues?

Zarate: Not yet.

Cook: Well, Jose, thanks very much for joining me. In a few months' time, obviously we will be closer to the U.K. election and then we'll have that to talk about when we look at the U.K. economy.

Zarate: OK.

Cook: From Morningstar, I'm Holly Cook. Thanks for watching.