EY ITEM Club Forecast: Outlook for Financial Services Spring 2014
Forecast in summary
EY ITEM Club's outlook for financial services Spring 2014 sees a more firmly entrenched recovery for the UK. However, the recent policy announcements and interest rates expected to rise from 2015 present some challenges for financial services.
“The UK economic landscape continues to exhibit a perplexing mix of features. A strengthening currency, falling inflation, and easing production costs (but with continued low productivity) mean the resilience of the current consumer-led recovery will be a concern if interest rates rise as expected over the next 18 months.”
Managing Partner, UK Financial Services
Read Chris’s forecast overview
The strength of the UK economy continues to surprise on the upside. This is to be welcomed, but there are still hurdles to come. Evidence is mounting that the UK missed an opportunity to develop its export markets while the window of cheap sterling and low interest rates was open. This is especially troubling now that the Eurozone is flirting with deflation and consumer demand in the emerging markets of Asia is increasingly turning inward.
Despite positive surprises, the UK economic landscape continues to exhibit a perplexing mix of features. A strengthening currency, falling inflation, and easing production costs (but with continued low productivity) mean the resilience of the current consumer-led recovery will be a concern if interest rates rise as expected over the next 18 months. ↓ [... more]
If the UK's economic landscape has the capacity to confuse, there is no comfort to be had from the UK regulatory landscape. The question of “suitability” within financial conduct is unclear, and an area of concern. Suitability carries responsibilities on both sides of the fence, for both financial services providers and financial services users. Both constituencies should clearly understand what their obligations are and be in a position to discharge them. The risk facing the UK market is that this is becoming increasingly untrue for both.
The suitability obligations imposed on financial services providers continue to march on, having moved well beyond an obligation not to mis-sell through to a requirement to monitor ongoing suitability through a product's lifetime. The next step may be towards a comparative testing of value against a current product environment.
Suitability has so far been assessed with the benefit of hindsight. But if policymakers allow the boundaries to be set by public opinion after the event they create a level of uncertainty which is likely to cause a contraction in product innovation and provision. A clear and reasonable standard needs to be struck soon.
Equally, customers need to understand their own obligations and responsibilities. The recent changes made to affordability testing for mortgages is welcome, as customers are now required to make a more considered assessment of their financial position and ability to fulfil all of their financial responsibilities.
The challenge is that this considered risk assessment is currently driven by the service provider. The majority of retail customers are not yet making this kind of assessment for themselves. Policy direction has seemed to focus on more and better data with which they can autonomously make an increasing number and range of financial decisions.
This push towards transparency and empowerment is to be applauded but it is based on a delicate hypothesis; that the customer has a sufficient understanding to use this data to make "better" decisions. There is still a long way to go before customers have a sufficient level of financial literacy and education. A key component is a strong retail advice market. Keeping customers updated and providing support around key decisions will be critical. An effective and balanced environment around "suitability" and the issues of education and advice need a more convincing policy landscape than we currently have.
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The UK recovery is looking increasingly sustainable and better balanced, with GDP expected to grow by 2.9% in 2014. There are positive signs that unemployment will fall to 6.8% by the end of 2014, consumer write-offs will decrease, and that house prices and property transactions will continue to increase. However, Bank Rate is expected to start rising in the second half of 2015 and changes to the annuities market announced in the Spring Budget will present challenges to both the insurance and asset management sectors as they compete for market share.
After contracting in 2012 and 2013, banks’ assets should see a modest rise this year from £6.5t to £6.7t, but profitability will remain subdued. Consumer credit should continue to expand by an average 4% a year during 2015-18. But business lending is expected to remain restrained, with only a 1.5% rise in 2014. We expect a 2.8% increase in mortgage debt in 2013, but rising house prices are unlikely to signal a mortgage boom.
Falling unemployment, plus improvements in the housing market and consumer activity should provide a boost for the general insurance sector. By 2017 non-life premiums are expected to finally exceed their 2007 peak, reaching £69b. A dip in life premium growth is expected in 2015 (a modest 2.1%) due to uncertainty in light of recent policy and regulatory announcements. However, we expect life premiums to recover to 3-4% growth over 2015-18 as insurers adjust to the changed annuity market.
In 2014 total assets under management (AUMs) are expected to reach £880b, up 9% on 2013. A strong increase in equity funds is anticipated, with a forecasted rise of 9% by 2014 as the economic recovery boosts investors’ appetite for risk and the Budget’s savings reforms kick in. In 2013, £16b was held in property funds a record high, and we continue to expect strong inflows over the next four years rising to £20b by 2018.