EY ITEM Club Winter Forecast 2014
Economic forecast in detail
UK GDP growth for 2013 as a whole looks likely to come in at about 1.9%, the strongest since 2007, before accelerating to 2.7% this year and 2.4% in 2015. However, to date the upturn has been driven almost exclusively by the consumer and the housing markets, which together accounted for the vast majority of the growth seen in 2013. In contrast, business investment detracted from growth in 2013, while net exports made barely any contribution.
Consumer confidence and spending
Consumer confidence has recovered as job security has improved, meaning consumers have been happy to help fuel the recovery by spending their savings. As a result, the savings ratio has fallen from 8% following the crisis to around 5%, stopping the fall in the debt/income ratio seen in 2012-2013. However, with real wages still under pressure, a continued rise in consumer spending would imply a further fall in the savings ratio, which would in turn lead to a renewed rise in households’ debt/income ratios. So, to sustain the recovery, the consumer will need help from business investment and exports.
Alongside the bias towards the consumer, a further imbalance in the recovery is that real wages are continuing decline despite rising employment and the long-awaited fall in inflation. Over the past two years the annual rate of CPI inflation has fallen from 4.7% to 2.1%, but any positive effect on consumer spending has been blunted by the accompanying fall in earnings inflation, from 3.2% to 1%. The continued slide in real wages is a weak spot in the recovery, and we do not expect the average earnings increases to catch up with inflation until the second half of 2014.
The employment market
It is difficult to find another recovery where rising unemployment has been accompanied by falling real wages. This unusual scenario has resulted from specific dynamics in the UK labour force, which has expanded by a net 750,000 over the past two years, swollen by immigration, benefit cuts, and, most significantly, delayed retirements. This expansion in supply has depressed real wages as people have priced themselves into jobs. Over the next two years the pace of growth in the labour pool will continue, albeit at a marginally slower rate. In terms of types of employment, the biggest increase in the past year has been in professional, science and technical jobs, underlining healthy demand for highlyskilled employees.
Business investment and exports
A revival in business investment and exports is vital for the UK recovery to become balanced and sustainable. With business confidence surveys now pushing record highs, we expect business investment to increase by 5% this year and another 9.3% in 2015. However these increases are still modest by the standards of previous recoveries. The UK’s export performance has also been disappointing for most of 2013, but with world trade underpinned by a US rebound and a slow Eurozone recovery we expect UK export growth to accelerate to above 5% by 2015, and remain at around that level through 2017.
The MPC and interest rates
The MPC has set a fall in the unemployment rate to 7% as the threshold for it to consider a rise in interest rates. However, with this threshold now in sight, but real wages still falling and the consumer continuing to dominate the recovery, the MPC faces a dilemma. In our view, the MPC should add a requirement for real wages to be rising before it increases interest rates, and should preferably hold off until business investment and exports have also revived. Fortunately, with inflation set to move below the 2% target, the MPC will have time to assess this situation, and we do not expect the first rate hike until the Autumn of 2015.