While the Conservatives’ victory removed some of the uncertainty hanging over the economy, it has some more worrying implications – such as the renewed fiscal squeeze and the EU referendum. But we think that the recovery will take these threats broadly in its stride. The latest GDP figures show that the economy has weakened, even before the fiscal squeeze starts again in earnest. And worryingly, economic growth slowed sharply when the previous stage of the fiscal consolidation really got going in 2011/12. Moreover, investment could suffer from uncertainty ahead of the referendum on UK membership of the EU that will take place by the end of 2017. However, there are reasons not to be too worried by all this. For a start, the business surveys have been painting a much more upbeat picture than the official GDP data. Meanwhile, the Conservatives might soften their planned squeeze, seeing as they have yet to explain how they will actually achieve the reduction in the deficit. Even if they initially stick to their pledges, having shown more flexibility than is generally realised in the last parliament, they would presumably relax the squeeze if the economy began to suffer. And evidence from the Scottish independence referendum last year suggests that the impact of an EU referendum might not be too bad. Lastly, there are various other factors which should be providing offsetting support to growth. Most obviously, the drop into deflation in the UK is giving a big boost to households’ real incomes. And we believe that real incomes further ahead will be supported by a pick-up in productivity growth.Admittedly, there are some other threats. Although the UK is better placed to deal with a Greek exit from the euro than it was when concerns were last this intense in 2012, a Grexit could have a damaging impact on the rest of the euro-zone economy – to which the UK is still heavily exposed. And the UK’s 5.5% of GDP current account deficit does not look sustainable.
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