EY ITEM Club Forecast: Outlook for Financial Services Winter 2014

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EY ITEM Club's outlook for financial services Winter 2013/14 forecast sees the improved outlook for the UK economy providing a solid base for growth in financial services. But the need to capitalize on the current positive environment and re-balance the economy will be key to maintaining long-term growth.

“The economic recovery of the UK appears to be accelerating more rapidly than most had predicted with GDP growth expected to average 2.4% over the next three years. The UK’s increasingly optimistic outlook is to be welcomed, but complacency would be disastrous.”
Chris Price
Managing Partner, UK Financial Services
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EY - Chris Price
Chris Price
Managing Partner,
UK Financial
Services

The economic recovery of the UK appears to be accelerating more rapidly than most had predicted with GDP growth expected to average 2.4% over the next three years. The UK’s increasingly optimistic outlook is to be welcomed, but complacency would be disastrous.

The UK has largely wasted its weak sterling window of opportunity to grow a larger export base. Now, the Government’s support and its fiscal policy will need to become the facilitator. In addition, the UK needs to deploy its own domestic investment base better, together with foreign investment, to overhaul ailing infrastructure if a recovery is to translate into long-term growth. The improvement in the UK’s economic data since our last forecast has been striking.

Predictions for output in 2014 have grown, whereas those for unemployment and inflation have fallen. As a result, concerns over potential obstacles, such as tapering and artificially inflated house prices, have begun to recede. Even more encouragingly, business investment is forecast to grow again this year by 5% as companies release some of their cash piles. If proved correct, this will help to rebalance the UK economy away from a purely consumer-driven recovery (although it remains an “if”). ↓ [... more]

So, can we all breathe a sigh of relief? Yes and no. On the upside, the UK looks increasingly well placed compared with many of its European counterparts. Our economy is emerging from recession sooner and faster than many of its neighbors’. This is reflected in recent research suggesting that the UK economy could even overtake Germany’s as the largest in Europe by 2030.1 Other leading economies, such as the US and even China, are now arguably more dependent on monetary stimuli than the UK.

Even so, not everything is looking rosy for the UK. We are not out of the woods yet, and the economy retains several significant structural weaknesses. One familiar problem is that, despite some improvements in other sectors of the economy, the UK has not yet rebalanced sufficiently away from financial services. A strong financial sector remains the cornerstone of the UK’s success, but it needs to be complemented by stronger growth in other industries. Realistically, this is unlikely to be a broad- based advance across all fronts. Policy needs to be better aligned behind some chosen sectors and some strong bets placed.

Another concern is that household savings rates have fallen steeply since the beginning of the recession. Even though we have forecast stable savings rates for 2014, they are not predicted to recover as strongly as overall levels of borrowing. Despite suffering the fallout from the credit-fueled excesses of the pre-crisis years, Britons today show few signs of emulating the behavior of their thrifty ancestors. Even if economic growth leads to a recovery in real wages, the absence of an everyday safety net could put many households under pressure when interest rates begin to rise. Retirement saving is the third area of potential weakness in the economy. Population growth may be a major driver of positive long-term projections for the UK, but it will not protect the economy from the effects of demographic aging. As the ratio of retirees to workers increases over coming decades, the inadequacy of pension provision – by governments, companies and individuals – will become all too apparent.

There are (at least) two great challenges with the UK pension system. First as a product, pensions have not exactly caught the imagination of a new savings generation. Second, pension funds have struggled to be active users of the capital they hold, given the nature of the products they have to fund. See for example, the difficulty the UK Government has had over the last couple of years attracting pension fund investment into infrastructure projects. It may be that for a new peer-to-peer lending or crowdsource funding generation, these issues are more closely related than we think.

What is clear is that enticing pension funds to increase their exposure to infrastructure will depend on aligning a number of financial, legal and tax incentives. This, in turn, will require something that does not always come naturally to the UK Government – strategic planning. Planning that is not (or at least is less) susceptible to five-year electoral cycles.

These are not easy issues to resolve. But if long-term enhancements could be added to short-term growth, then we really would have something to celebrate.

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Solid UK economic growth – with GDP expected to grow by 2.7% this year – is contributing to increases in total lending, insurance premiums and assets under management (AUMs). With unemployment also set to fall and real wage growth to turn positive in 2016, greater confidence should help drive financial services. However concerns remain that growth continues to be imbalanced towards the housing market and high street.

Some banks are expected to start expanding assets again between now and 2016 and the improved economic environment is expected to boost mortgage and consumer lending. Business lending hit a five-year low in 2013, but is set to recover this year (rising 2.5%), however it still remains well below the 2008 peak.

Life and non-life premium growth was more resilient than expected in 2013, and a firm but protracted recovery path is forecast for both. The boost in property transactions to 1.3m by 2017 should increase demand for insurance products. Even though profits will reach £191b this year, they are not expected to exceed their 2007 peak until 2017.

Solid growth is forecast for asset managers with AUMs expected to exceed £1t by 2017. Equity funds are expected to rise 7.4% in 2014, and multi-asset funds should overtake bond fund AUMs by 2015. The upturn in the property sector has rekindled investors’ interest and property AUMs are expected to grow 7.7% a year over 2014–17.