EY ITEM Club Spring Forecast 2014

Economic forecast in detail

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GDP growth

The economic recovery is becoming more entrenched and better balanced. Although the recovery so far has been mainly driven by consumer spending, investment is increasingly making its presence felt. So while the UK economy is not completely out of the woods, 2014 will be a year of decent – if not spectacular – growth, which should be sustained over the coming years. We expect UK GDP to expand by 2.9% this year and 2.3% in 2015, with interest rates staying on hold until the Autumn of 2015. 

UK: Contributions to GDP Growth

Source: EY ITEM Club

The wider economic outlook

While the primary engine of the recovery has been consumers switching from saving to spending, there are several indications that the upturn is now moving to a sounder and more balanced footing. The tightening labour market and falling inflation will boost real wages as well as employment, helping to sustain consumer spending. But business investment is now also kicking in, supported by high levels of corporate cash and confidence. More tentatively, exports are strengthening as the UK’s major overseas markets recover. Together, these factors hold out the prospect of a long period of sustained, low-inflation expansion.

The buoyant labour market…

Throughout the downturn, the UK employment market remained more resilient than many observers expected. The single-month figures for January saw unemployment dip below 7% for the first time since 2009, while employment growth and labour demand remain solid. These drivers are finally starting to filter through to earnings growth, with earnings expected to overtake prices within the next couple of months. 

…is kept in focus by the Chancellor’s new target

With the Bank of England’s Monetary Policy Committee dropping its 7% unemployment threshold for reviewing interest rates, the Chancellor has maintained the focus on the labour market with a new ‘full employment’ target based on the share of 16 to 64-year-olds in work. The aim is to make this ratio the highest in the G7 by applying microeconomic tools. With the flexibility of the UK labour market helping to bring unemployment down and push employment up, our forecast suggests this target could be achieved.

Inflation

Inflation, as measured by the Consumer Price Index (CPI), is set to stay below 2% through 2014-2016 thanks to several factors. The growing workforce, supplemented by ongoing immigration and government payroll cuts, will help to hold wage rises down. The relatively strong pound will limit import costs, while industry will also benefit from subdued energy and commodity prices, as the Chinese economy rebalances from investment to consumption. And higher business investment in the UK will revive productivity and help keep businesses’ costs under control.

Business investment and exports

With business confidence indicators hitting record highs, and capacity and staff shortages intensifying, business investment will rebound, boosting productivity and real growth in wages. After falling 0.6% in 2013, fixed investment is set to surge by 9% in 2014, before decelerating slightly year-on-year to 7.3% in 2017. This is one half of the much-heralded rebalancing of the economy – the other being a resurgence in exports. While exports recovered well in the second half of 2013, this improvement was offset by a fall in overseas investment income. But export orders remain buoyant despite the strong pound, and exports should strengthen further as world trade accelerates, growing at 5%-plus through to 2017.

The housing market

Housing investment has recovered sharply, and the resulting rise in supply will help to keep a lid on price rises in most of the country. However London remains a special case, where surging prices have pushed mortgage income multiples close to their pre-crisis peak. So it is vital that the Financial Conduct Authority (FCA) prevents income multiples from getting too stretched in London. If these controls are rigorously applied, this will eventually constrain London prices – and head off severe problems when interest rates rise.

UK: Income multiple, 2013

Source: EY ITEM Club calculations using ONS data

Peter Spencer, Chief Economic Adviser to EY ITEM Club