Ernst & Young ITEM Club UK Spring Forecast 2013

With inflation running ahead of wage increases since 2009, consumer spending has been largely subdued for the past four years, as people channel their cash into paying off debts rather than spending in the shops. However the inflationary headwinds have now eased, with employment also picking up and the Budget measures in housing and personal tax set to feed through to disposable incomes. The stage is set for last year’s modest recovery in consumer spending to continue, accelerating to 2.2% in 2015.

UK job numbers have held up remarkably well during the downturn and with employment rising and jobless queues shortening, total income from employment rose by 3.1% in 2012, narrowly outpacing CPI inflation. While 2013 will see employment growth go back to 250,000 from last year’s 600,000, the Budget measures will help to maintain growth in real disposable incomes, thus sustaining the rising demand for mortgages and consumer goods.

UK: Employment growth, 2002-2016

Source: ITEM Club

Budget changes in personal tax allowances are not usually a cause for great excitement on a macro-economic level. But this Budget was different, delivering an increase in personal allowances that will add £250-£300 a year almost 0.5% to the disposable income of the average standard-rate taxpayer. This is a very significant boost. And with the gains concentrated at the lower end of the earnings scale, the extra money will mostly be spent rather than saved.

The UK housing market is now seeing a win-win of rising disposable incomes and increasing affordability factors whose impact will be multiplied by the Chancellor’s ‘Help to Buy’ scheme. With £3.5bn of government funds paying 20% of the purchase price, the scheme can underpin 100,000 mortgages worth £200,000 each. As a result, we think one million families will move house in the coming year, a sharp increase from the recent level of 800,000, driving higher house prices, additional housing-related spending, and ultimately construction.

UK: Housing market, 2002-2016

Source: ITEM Club

If this forecast has seemed unusually optimistic until now, then the UK’s export prospects bring us back to cold reality. With the outlook in key European markets remaining bleak, and many other countries also banking on an export-led recovery, rebalancing the UK economy is on hold. UK exporters may be helped by the pound’s  recent decline. However, any hopes of a significant boost from the lower pound are  being dampened by the fact that the much bigger falls in 2007 and 2008 had comparatively  little effect.

The past two years have seen several major UK exporters in industries such as Automotive  and Aerospace announce aggressive investment and expansion plans. But a more  general recovery in investment looks unlikely until domestic and overseas demand recovers  more convincingly. Despite UK plc’s strong balance sheets, business spending is still being  limited by spare capacity and low confidence factors that will see it grow just 2.2% this year, rising to 8.1% in 2014.