EY ITEM Club Outlook for Financial Services Spring 2015

Summer 2016

Outlook for financial services

EY ITEM Club

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The UK’s vote to leave the EU has injected a major degree of uncertainty into the economic forecast. A weaker outlook for the UK economy seems likely. The EY ITEM Club has forecast 1.9% GDP growth this year compared to our last forecast of 2.6%.

Financial services will feel the effect of uncertainty. Though, there will be some relief through interest rate cuts and a potential change in the government’s austerity policy.

Our EY ITEM Club Outlook for financial services believes the strong fundamentals of the sector do give reasons for optimism such as the UK’s robust banking industry, higher levels of capital and liquidity, rigorous regulation.

The recent decision to leave the EU has clouded the prospects for the economy and for financial services, just when the fundamentals were looking positive.  Consequently the latest ITEM Club Outlook for financial services presents a less certain picture than my first Outlook as EY’s UK FS Managing Partner six months ago.

For financial services, much of the uncertainty surrounds the timetable for the UK to exit the EU, the manner in which it will do so, and the terms that can be agreed. Very few will be making substantial decisions until a clearer view emerges.  For now it’s the second order effects of the referendum result that firms are contending with – notably the impact on the UK economy and consumer confidence.”
 
Omar Ali
Managing Partner, UK Financial Services
Read Omar’s forecast overview

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Financial services firms are well placed to ride out post referendum uncertainty


EY - Omar Ali
Omar Ali
Managing Partner,
UK Financial Services

The recent decision to leave the EU has clouded the prospects for the economy and for financial services, just when the fundamentals were looking positive.

Consequently the latest ITEM Club Outlook for financial services presents a less certain picture than my first Outlook as EY’s UK FS Managing Partner six months ago. ↓ [... more]

For financial services, much of the uncertainty surrounds the timetable for the UK to exit the EU, the manner in which it will do so, and the terms that can be agreed. Very few will be making substantial decisions until a clearer view emerges. For now, it’s the second order effects of the referendum result that firms are contending with – notably the impact on the UK economy and consumer confidence.

Before the referendum, we predicted economic growth would rise to 2.6% this year and 2.3% next year. We have now cut those figures to 1.9% in 2016 and 0.4% in 2017. The forecast for 2018 has been revised to 1.4% from 2.2%.

Financial Services are well placed to ride out post-referendum uncertainty.

The revised forecast is disappointing, but it’s not a slide into recession. Rather, it means a slowdown in growth. Without wishing to underplay the macro-economic impact of the Brexit decision, the nature of the change is still a long way from the type of shock suffered by financial services during the crisis of 2008. Factors such as the strength of the UK’s banking industry, higher levels of capital and liquidity and the rigorous levels of regulation that our financial services firms have to meet, are all good signs that the sector is well placed to ride out this immediate period of uncertainty.

True, earlier optimism about low inflation, falling unemployment and rising pay has been replaced by concerns about the impact of prolonged low interest rates, the implications for Non-Performing Loans (NPLs) and falling confidence among consumers and businesses. However, the response, to the referendum in financial services has been calm and measured.

Already some of the market turbulence that greeted the referendum result has abated, helped by the rapid appointment of a new Prime Minister, and a swift but measured response by the Bank of England.

Recovery in bank lending pushed out to 2019 and growth of AUMs curtailed

The revised economic forecast will affect financial services players in different ways. 2016 was previously expected to be the first year since 2011 to see a rise in total bank lending, but the forecast for weaker economic growth means that demand for credit will weaken. Mortgage lending and consumer credit are still set to grow, albeit slower than hoped, but business lending is expected to shrink by 1.8% next year and the recovery in total lending has been pushed out to 2019. Banks also face a squeeze on net interest margins and depressed profits from lending due to prolonged lower interest rates.

A combination of cooler consumer demand and low rates will squeeze profitability in the insurance sector, with profits estimated to decline for the first time since 2012. Brexit should be less pressing for life companies, especially if equity markets don’t weaken significantly, but the sector will continue to grapple with long-standing issues such as increasing longevity, and the effect of long-term low interest rates.

Wealth and asset managers have been some of the quickest to react to Brexit, with many launching new products and raising redemption fees in response to the revised economic outlook. In the longer term, some of the biggest changes for this sector will stem from slower growth in household wealth, which will impact assets under management (AUM), and a ‘risk-off’ approach by investors likely to favour safer assets. This will create a more challenging environment for the sector – AUMs are now forecast to rise by just 1.5% per year from 2016-19, compared to 11.3% from 2012 to 2015. Inevitably this will also create opportunities for those that are able to take advantage of a flight to quality.

Outlook

Much focus has been put on the potential political outcomes following the referendum, and that’s right – the result of the negotiations stand to have a lasting impact on the shape of the UK’s financial services sector and as an industry we need to speak with one voice to inform and shape policy. But we shouldn’t overlook the second order impacts. For now, the landscape in which financial services firms are operating has altered. Consumers and businesses are going to think twice before they borrow, and be careful about what they invest in, and low interest rates look like they are here to stay. This economic environment isn’t that different from what the sector has been contending with over the past eight years of change and challenge. In fact, thanks to the rigour instilled in their businesses through the crisis, the financial services industry is probably amongst the sectors best placed to deal with this within the UK.

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