Invesco's Greenwood reveals expectations for UK economy

Invesco's Greenwood reveals expectations for UK economy

Investors shouldn’t expect the current level of inflation to continue in the UK and the economy should improve as a result, according to John Greenwood, chief economist at Invesco Perpetual.

Mr Greenwood said a combination of higher inflation - the current UK inflation rate is 3 per cent - and weakness in the levels of business investment caused by uncertainty around the Brexit negotiations have caused UK economic growth to slow.

He said: "I would expect the rise in inflation to be relatively short lived, subject to what the Bank of England does. Therefore, we ought to see some improvement, certainly after the Brexit process is over."

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While there is a strong element of consensus among market participants that the above target inflation in the UK is almost entirely the result of weak sterling, many investors see the current exceptionally low rate of unemployment as a portent for persistently higher inflation.

Traditional economic theory, called the Phillips Curve, states that falling unemployment leads to higher inflation.

This happens for two reasons, the first is that as more workers get jobs, their incomes rise relative to when they were out of work, so they have more spending power, this pushes up demand for goods and services, so prices rise.

The second way in which higher employment levels leads to higher inflation, is that it forces employers to put wages up as there are fewer workers.

But despite unemployment falling in the US and UK, inflation has been muted.

Mr Greenwood said this is because inflation only rises at an exceptional rate if the workers in jobs and the companies employing them respond by borrowing more, and workers in much of the developed world have responded by paying down debt, so inflation hasn’t risen sharply, and he doesn’t expect this to change.

Jacob De Tusch Lec, who runs the £3.8bn Artemis Global Income fund, has positioned his fund for a pick-up in global inflation, and said he expects the theory behind the Phillips Curve to be vindicated in the coming years.

Mr Greenwood said he expects the currency driven rise in UK inflation to fade as the market gets greater certainty about what the post-Brexit arrangements will be.

He said he expects economic growth to pick up as bank lending has been rising.

He said it was rising before the Brexit vote, and so the Bank of England’s interest rate rise in the immediate aftermath of the vote was a “mistake.”

With that in mind, he agrees with the central bank’s decision to put UK interest rates up in November 2017, as it reversed the previous error.    

The Invesco economist believes the Bank of England should now follow the strategy of the US central bank, the Federal Reserve, and very slowly increase UK interest rates in the years ahead.

This is because if rates don’t rise when lending is rising, an unsustainable level of inflation will occur for a prolonged period of time, and eventually lead to a recession.