Economists’ insight: T. May’s strategy fails in the UK, ECB remains in control

Macro Highlights - 6/14/2017

In short
  • Economists’ insight: T. May’s strategy fails in the UK, ECB remains in control
  • Focus on India: Growth potential still intact

Key Takeaways of the week with Sophie Casanova, Economist, Central Banks and François Léonet, Economist, Emerging Markets

Theresa May’s strategy fails in the UK, ECB remains in control 

  • The Conservatives have lost their absolute majority in the British parliament, further weakening the government’s ability to negotiate the UK’s exit from the European Union
  • Uncertainty surrounding the outlook for the UK is expected to remain strong and impact activity levels over the coming quarters. In line with our expectations, the pound sterling could fall significantly
  • Although more confident about the outlook for growth, the ECB has confirmed that monetary tightening is not imminent. The euro’s upside pressures are therefore expected to be limited

The results of the general election, which she wanted to hold earlier than scheduled, have fallen far short of the expectations of UK Prime Minister T. May. Her party, the Conservatives, not only failed to increase their number of seats in parliament, but also lost the absolute majority they had held up until now. Following the election on 8 June, the Prime Minister has seen the number of seats held by her party cut from 331 to 318, below the 326 seats needed for an absolute majority.

T. May’s strategy was simple: in April 2017, when surveys indicated that the Conservatives had a substantial level of voting intentions, she chose to hold an election earlier than expected with a view to strengthening her party’s position in parliament and gaining the domestic leeway needed to conduct negotiations for the UK’s exit from the European Union.

But once again, public opinion gradually changed and the outcome of the election turned out to be very different from what the country’s leaders were hoping for.

To be able to effectively conduct its negotiations with the European Union, the British government will now need to establish alliances, particularly with the Democratic Unionist Party. This is adding to the uncertainty surrounding the British authorities’ ability to define clear guidelines for their strategy throughout this lengthy process.

The levels of uncertainty in the UK, which were already high, could increase. Especially since the strengthening of the Franco-German unit, following E. Macron’s election, over and above advances for the eurozone, is expected to support a strengthening of cohesion within the European Union. [...] 

Sophie Casanova, Economist, Central Banks





Growth potential still intact

  • With 6.1%, GDP growth for the first quarter of 2017 was disappointing and reflects the delayed – and higher-than-expected – impacts of the demonetisation, as well as statistical biases. This slowdown is expected to be temporary

  • Private consumption has continued to trend up, while the legislative elections at the start of the year reinforce N. Modi’s political legitimacy

  • Private investment is still the weakest link and needs to be supported by bank lending


India reported real GDP growth of 6.1% for the first quarter of 2017, compared with 7.0% the previous quarter. This figure is lower than the consensus expectations (7.1%), as well as our own growth forecasts (6.9%). This slowdown partly reflects the delayed impact of the demonetisation from November 2016 on the formal economy, as well as various statistical biases, mainly when calculating the GDP deflator. The consequences of the demonetisation can also be seen in the informal sector, as shown by the -3.7% contraction in construction activity. This segment is one of the main recipients of the flows of undeclared money that were specifically targeted with the demonetisation operation.

This slowdown in growth is expected to be temporary and the Indian economy looks set to continue trending up in 2017. Household consumption, buoyed in particular by public sector wage growth and the drop in inflation to 3% – below the official target of 4% –, is still the leading contributor to the country’s growth. The quantity of money in circulation is close to nearly 80% of the level seen before the demonetisation, while the positive trends for leading indicators point to an upturn in economic activity (see right-hand chart). Growth is expected to reach 6.9% for the calendar year in 2017 and 7.8% for 2018, driven by the structural reforms. [...]

François Léonet, Economist, Emerging Markets