Probably the biggest challenge next year in the UK will be to see if wages rebound after the muted growth seen throughout the post-crisis period. Weak pay growth also remains one of the primary reasons why the BoE remains cautious about increasing interest rates, given the high level of household debt and surging house prices.
Overall, the UK economy remains relatively strong, translating into buoyant business confidence and investment, strong household spending, and a robust and tighter labor market.
But the economy has been struggling with persistent deficits on trade in goods since 1998. This partly reflects a stronger pound, volatile oil and gas extraction, and a decline in manufacturing over the latest decades. That is why the UK has been overly reliant on its domestic spending, which has been helped in recent years by highly accommodative monetary policy.
Given that household spending is among the primary macroeconomic drivers, wage growth is set to remain one of the top challenges next year. Weak earnings also remain one of the primary reasons why the Bank of England (BoE) remains highly cautious about increasing interest rates, given the high level of household debt and surging house prices.
Real pay remains boosted by very low inflation at the moment, but economists expect the annual rate of CPI to start picking up next year, and with wages rising at an average of just 1.5%, the wedge between nominal pay and inflation is seen squeezing soon.
Even though wages, measured by weekly average earnings, have been picking up slowly from post-crisis lows, pay growth has remained notably below the pre-downturn levels. While regular earnings increased on average by 4% before the economic downturn, between 2001 and 2008, the same measure of pay was rising just 1.5% on average between January 2009 and September 2015.
BoE Deputy Governor Jon Cunliffe reiterated recently the significance of the UK household spending segment on the overall economy: "Wages are immensely important for two reasons ... One because the forecast we have of what happens in the economy is dependent in a large part on consumers ... and consumers can finance some of that consumption through savings, but they really need that increase in pay to do it ... It's also important because we need pay pressure to push inflation back up to 2%."
BoE policymaker Minouche Shafik said in December that in order to generate inflation at the 2% target in the medium term, UK nominal wages would have to rise around 2% to 3% faster than productivity growth, which she said has so far averaged at just around 1%.
On the outlook, Shafik said: "The most likely outcome is that wage growth will soon resume its recovery, but there are alternative states of the world in which it takes longer for that to happen. So I judge it prudent to tread carefully, and refrain from voting for an increase in Bank Rate until I am convinced that wage growth will be sustained at a level consistent with inflation returning to target."
Growth and inflation outlook
The latest official figures showed economic growth was revised slightly down in both the second and third quarter of 2015. Forecasters from IHS Global Insight have consequently trimmed their 2015 outlook for annual GDP growth from 2.4% to 2.2%, before picking up to 2.4% in 2016.
IHS chief economist Howard Archer argued in his most recent comment that "the fundamentals should still be pretty decent for consumers in 2016," while inflation is set to remain weak, and "muted oil and commodity prices will also help companies' margins, which should be supportive to business investment along with generally healthy company cash positions and relatively favorable credit conditions overall."
In its latest outlook for growth, the UK's National Institute of Economic and Social Research (NIESR) said the economy over the medium term was expected to become more balanced, as improving economic conditions in Europe would lead net trade to offset a moderation in domestic demand growth.
The Office for Budget Responsibility (OBR) expects the economy to grow by 2.4% in 2016. The OBR also upped the growth outlook for 2017 by one basis point to 2.5%, before sliding to 2.4% in 2018, and slightly lower to 2.3% in 2019-20.
Policymakers at the central bank remain concerned about a prolonged drag from new falls in oil prices, arguing in the December Monetary Policy Committee minutes that "If the declines in the price of oil that had occurred in the days running up to the Committee's meeting were to persist, the expected path of CPI inflation in the spring would be slightly lower than at the time of the November Inflation Report." The BoE expects annual rate of CPI below 1% until the second half of next year.
EU referendum risks
Among the most significant risks next year to stir up uncertainty in the UK is the looming EU referendum. Very much will depend on the UK's re-negotiation efforts with its EU partners. The better the news, the less ammunition for anti-EU forces in the UK, and more tools for Prime Minister David Cameron to push public opinion towards Britain staying in the EU.
The latest news suggests Cameron managed to secure a partial deal with other member states in Brussels, with some media reports speculating the EU plebiscite could be held as early as next year to reduce an increased level of uncertainty.
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