The British gross domestic product (GDP) is forecast to grow 2 percent this year, and a slower 1.4 percent next year, according to a forecast published on Wednesday by the National Institute for Economic and Social Research (NIESR).
NIESR revised its 2016 growth expectation upwards since its last forecast in August, supported by stronger third quarter official growth figures than it had anticipated.
"One quarter's respite is just that, and the longer term prospects continue to be worrying and I ought to note that there is significant event risk attached to the triggering of Article 50," Jagjit Chadha, NIESR director, told a press briefing.
The British government's announced intention to begin exit from the European Union (EU) by triggering Article 50 next March, namely, starting the formal Brexit process, represents a significant event risk to the 1.4-percent growth next year.
Many economists had predicted a rapid decline in economic growth and other problems as a result of the Brexit vote. This has not yet materialized, except for a large fall in the sterling rate. Simon Kirby, principal research fellow at NIESR, said:
"The positive outturns for GDP growth in the near term are very welcome, but these give little to no guidance as to what will be the long run impact from leaving the EU will be. The depreciation of sterling has been the most striking feature of the post-referendum economic landscape."
In the past three months, sterling hit a 31-year low against the U.S. dollar and a five-year low against the euro. Sterling had declined 15 percent on a trade-weighted basis since June 23, and now stands at 1.22 dollars to the pound, having touched 1.48 dollars prior to the result.
The resulting weakness in sterling purchasing power is expected to pass through into sharply rising inflation figures over the next two years, and NIESR has revised its Consumer Price Inflation (CPI) expectation up to 3.5 percent for 2017 and 2018, before returning towards the monetary policy target of 2 percent by 2020.
Kirby said that the impact on consumer spending of the decline in sterling against other currencies had already begun to be felt. The decline had already started to pass through to consumer prices and producer prices in the economy, said Kirby.
"This will continue to evolve in the coming months and is behind the considerable uptick in the rate of inflation in our forecast. By the second quarter of 2017 we do expect the rate of inflation to be above 3 percent. It is expected to reach just under 4 percent by the end of 2017."
Kirby said that NIESR forecast the Bank of England interest rate, which was cut 25 basis points to 0.25 percent in August in response to uncertainty around Brexit affecting the economy, to remain at 0.25 percent until the third quarter of 2019.
"We are assuming that they will keep the bank rate on hold through the withdrawal negotiation from the European Union."
Kirby said household consumption had driven growth in 2015 and 2016. "Over the course of 2017/18 as uncertainty and the impact of the sharp rise in inflation come into play, that contribution from consumer spending is depressed dramatically," he said.
"What is underpinning growth in 2017 is not domestic demand, we expect that to contract by a modest amount; the positive contribution is coming from net trade in 2017 and 2018.
"It is the sharp turnaround from a negative to a positive contribution from imports; in effect that is saying that import volumes are expected to fall over the next couple of years and that is related to the weakness of the domestic economy."
The trade balance is expected to benefit from the fall of sterling as export volumes will increase and import volumes will decline.
Alongside an improvement in the primary income balance, the current account deficit is predicted to narrow sharply from 4.5 percent of GDP this year to 1.7 percent in the next and reaches surplus in 2019. The slowdown in economic activity as the economy grows at a reduced rate, coupled with uncertainty, could lead to a delay in firms' hiring plans which NIESR forecast would be only partially offset by weak real wage growth.
NIESR forecast unemployment to peak at 5.6 percent in 2017, before gradually returning to its long-run level. The corollary of this is that labor productivity growth remains muted.
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