Preview 2018: What next year promises for economics, sterling, Brexit and stocks

The political outlook can be expected to play an unusually large role in driving activity and sentiment

An analyst at one American investment bank claims a Labour government could pummel the domestic stock market (EPA)

Some 2,017 years ago three wise men followed a star to Bethlehem. And earlier this year six wise men and one wise woman at the Bank of England did something they haven’t done in more than a decade: they voted to raise interest rates.

The monetary magi had gazed into the heavenly data and collectively discerned a risk of inflation getting out of hand if they didn’t increase the cost of borrowing for firms and households across the country.

But will we see more interest rate hikes from the bank in 2018? The message was certainly what that the Bank’s governor, Mark Carney, tried to impart to financial markets, as rates went up in November from 0.25 per cent to 0.5 per cent.

But the reaction of the traders suggested that they weren’t convinced. Sterling failed to climb as many at the bank had expected and slid instead.

The most important indicator for the rates outlook is probably domestic wages. The import-price shock caused by the record sterling slide in the wake of the Brexit vote now seems to be working its way out of the system.

The most recent data shows pay packets still growing at a tepid rate of around 2.5 per cent a year, well below the pre-2008 expansion rate of 4 per cent plus. And two members of the Bank’s Monetary Policy Committee (Sir John Cunliffe and Sir Dave Ramsden) voted against increasing rates in November because they were not convinced, unlike their seven colleagues, that wages really are about to come back strongly.

If wage growth fails to climb to an annual rate of 3 per cent in 2018, up from around 2.25 per cent this year, expect sterling to lose ground against the dollar and euro. That’s especially likely if, as has happened in 2017, the US and eurozone economies perform more strongly than the UK’s.

Indications from the Federal Reserve are for around three further rate hikes in 2018 as they seek to cool the mighty US economy as it picks up speed. The European Central Bank will also start to “taper” its €60bn-a-month money-printing programme as the single currency area’s cyclical recovery continues next year. Upside surprises for those countries will mean a faster pace of monetary tightening. And growth downside surprises for the UK could spell the opposite here.

With British GDP growth already widely expected to slow still further in 2018 as Brexit approaches and firms freeze investment, it is no great surprise that many traders think the Bank may not hike again for some time – perhaps even being forced to reverse its November rate hike if things get particularly hairy.

As usual, the currency will be the canary in the economic coal mine. Signs of robust wage inflation, pushing headline consumer price growth back above 3 per cent, and progress towards a Brexit transition deal will boost sterling from its current level of $1.3374. Alternatively, economic weakness and bust-ups in the Brexit talks will depress sterling, possibly to $1.20 and parity with the euro, according to some bearish analysts.

What does that mean for share prices? The multinational-stuffed FTSE 100 had a weak year in 2017, rising 6.3 per cent, trailing the 20 per cent gain in the American S&P 500. That follows the FTSE’s 17 per cent surge in 2016, when the record sterling plunge in June automatically boosted the blue chip index.

As ever in the world of finance, everything is tied to everything else, like a camel train in the desert. Upside surprises on inflation can be expected to send sterling up and depress long-term UK government bond prices in anticipation of a series of more rapid rate hikes from the Bank of England to cool demand. Weak wage inflation combined with soggy GDP growth and bad news from the Brussels negotiating chambers is likely to act in the opposite direction.

A fresh shock for the pound would likely boost multinational share prices, just as it did in 2016. But shares may also get a relief fillip if a smooth Brexit comes into clearer focus.

But what if Theresa May’s Government founders on the back of internecine Conservative strife over Brexit compromises? What if a snap election becomes a possibility and the prospect of a Labour government crystallizes? Shadow Chancellor John McDonnell boasts he is actually war-gaming a run on the pound. An analyst at one American investment bank claims a change of government could pummel the domestic stock market.

Self-interested fear-mongering by City types who don’t want to pay more tax under Labour? Possibly. But for Britain, the political outlook can, nevertheless, be expected to play an unusually large role in driving activity and sentiment. Our financial future may be written not in our stars, but in our febrile politics.