EY ITEM Club Autumn forecast
Economic forecast in detail
GDP growth will continue – albeit at a slowing pace
The ONS’s recent revisions to the UK’s historical economic data have given a very different perspective on the shape of the recession and subsequent recovery. UK GDP has been revised up, meaning it actually passed its previous high-point in 2013, and that output is now well above the 2008 peak. This picture is more consistent with the strong growth in employment, although the “productivity puzzle” remains. The upward revisions to business investment have been particularly pronounced, meaning the scope for catch up is less than previously thought. Despite the growing risks and uncertainties, we’re projecting GDP growth of 3.1% in 2014, followed by a slight easing to 2.4% growth in 2015 and 2.3% in 2016, and then a modest uptick in 2017.
Business investment has been a major driver of the recovery…
The ONS’s revisions underline the extent to which business investment has been the engine powering the UK’s economic recovery. Despite capital spending representing less than a fifth of the economy, investment growth accounted for almost half the rise in GDP in the year to the second quarter of 2014. Indeed, Q2 2014 saw UK firms’ capital spending rise by 3.3% from the previous quarter, more than five times the growth in consumer spending. That companies are now willing to draw down their substantial cash piles is good news for investment. And with growth in consumer spending now firmly entrenched – see our recent special report – and borrowing costs set to remain historically low for the foreseeable future, there are clear incentives to keep investing.
…but is now threatened by risk and uncertainty
However, the revisions have also reduced the scope for catch-up growth in business investment, at precisely the time when multiplying political risks and uncertainties are threatening to make businesses feel more cautious and rethink their investment plans. The causes of uncertainty are legion – ranging from the impact of the Scottish referendum to the UK general election and possible EU membership referendum at home, to global risks including the slowdowns in the Eurozone and emerging markets, the Ukraine crisis, and more. Despite these headwinds, we expect business investment to grow by 9% in 2014 and 5.8% the following year. So investment will still be punching above its weight in driving the economy’s expansion – but less strongly than before.
Exports are hit by the strong pound and Eurozone weakness…
While the UK economy is continuing to grow, there is an increasing split on sectoral lines. On the one hand, services and construction are continuing to push ahead, supported by the relative strength of the domestic economy. But on the other, manufacturers have moved back into the slow lane in the face of weak demand from the Eurozone and the effect of the strong pound, which has made UK exports less competitive in our main continental markets. As a result, the glimpse seen earlier this year of a rebalancing of economy towards manufacturing and exports now appears to have been a false dawn – at least for now.
…but inflation will remain low
Inflation as measured by the CPI was just 1.2% in September, the lowest reading in five years and ninth successive month that it has been below 2%. While falling prices for food and petrol have played a role in keeping inflation down, underlying price pressures are also well contained. September’s producer prices data suggested that input costs are down more than 7% year-on-year, and import prices are falling due to the strength of sterling and very low inflation in the Eurozone. The silver lining of the weaker performance of emerging markets is the downward pressure it is putting on commodity prices. This should help to keep inflationary pressures subdued and our forecast shows CPI inflation averaging just 1.3% in 2015. This will enable the MPC to keep interest rates at 0.5% until at least the spring, if not longer.