Strong economy, risky strategy

How confident are you about the likely success of the economic plan presented by Chancellor George Osborne in his recent Budget?

According to the EY ITEM Club, his plans are ‘risky’ and could contribute to a slowdown in UK economic growth.

The EY ITEM Club is always worth considering, as they use the same economic model as that used by HM Treasury.

Despite saying the economic plans for the country were risky, they also note that the UK economic position is strong.

Strength in the economy is mainly the result of low price inflation, because of continued low oil prices.

The EY ITEM Club expects UK economic growth to be 2.7% in 2015 and 2016 before it slows to 2.4% in 2017 and 2018.

Price inflation is forecast to rise in the medium-term, and this could result in slower consumer growth, according to Peter Spencer, chief economic adviser to the EY ITEM Club.

One reason they describe the economic plan is risky is the pressure it will place on business.

Spencer explained at businesses will take on more responsibility for low wage employees through the National Living Wage. They will also need to increase investment in order to boost productivity.

Peter Spencer said:

“Everybody knows the chancellor has handed over responsibility for looking after those at the bottom end of the scale essentially to companies through the living wage – that’s substituting for all of those tax credits.

“But also, he’s relying on companies to step up their investment and training plans and of course exports, basically to keep the economy going as households, that’s you and me, begin to tighten our belts in response to the big tax increases in the Budget,”

The strength of the economy often drives investor sentiment.

When prospects are good for economic growth, investors will often be tempted into ‘risk assets’ such as equities.

Fears about a slowing economy will send investors in search of ‘safe havens’.

History tells us however that economic growth and investment growth are not necessarily correlated.

One piece of academic research supporting this low correlation was the Vanguard White Paper:

The Outlook for Emerging Market Stocks in a Lower Growth World

This concluded, “We find that the average cross country correlation between long-run GDP growth and long-run stock returns has been effectively zero.”

So whilst economic growth matters for all of us, whether we are in work or receiving welfare benefits, it might matter less for your investment portfolio.