Forecast in summary
Uncertainty over the general election is mounting, but the economy will take this in its stride. Official statistics for the first quarter of this year have been unambiguously negative, but will be revised up into line with business surveys, which are now much more positive. The forecast shows GDP growth of 2.8% this year and 3.0% in 2016.
CPI inflation will average 0.1%, this year. It will be difficult to raise the base rate while inflation remains below 1%. CPI inflation will move back above 1% this Winter as base effects fall out of the calculation, paving the way for the first rate increase in the Spring of next year.
The strong labour market and benign inflation and interest environment is very supportive for the consumer. With real incomes up 3.7% this year, the forecast sees consumption growth of 2.8%, with strong growth over the medium term sustained by the buoyancy of income rather than borrowing.
It is clear that we are now looking at the mirror image of the storm that hit the economy in 2010-12. China and the EMs that drove the world economy and commodity prices up then have slowed dramatically. Oil and other commodity prices have fallen back dramatically. Good harvests and supermarket price wars have also helped to bring down the prices of food and clothing in the shops. To complete this pretty picture, the Eurozone economy has staged an impressive recovery, and the pound has reversed the steep fall against the Euro seen in 2007 and 2008.
The Eurozone was picking up before the ECB announced its quantitative easing (QE) programme, based on a recovery of consumer confidence and spending in countries like Germany rather than the usual boost from exports. This recovery is also evident in countries like Spain in the periphery. Now, QE is now adding to the momentum by depressing the Euro and long term interest rates, as well as boosting liquidity and the money supply.
The fall in the Euro against the pound will add weight to the forces bearing down on UK inflation and buoying up consumer incomes and spending. Recent business surveys suggest that its effect on export competitiveness has been offset by the strength of the European market, without adverse effects on UK export performance. Moreover, the impressive revival in European equity and property markets will help repair the damage they have done to the UK’s invisible earnings in recent years.
Judging by the strength of the storms that hit us in 2010-12, these favourable developments should make the economy robust enough to ride out political shocks from the UK election. Similarly, we believe that the Eurozone and the oil markets respectively should be able to withstand possible shocks stemming from a breakdown of negotiations over the Greek austerity or Iranian nuclear programmes.
While we accept the need for an official watchdog to be cautious, our forecasts are significantly more positive than the OBR Budget projections. We see more room for expansion in the revenue-rich consumer and housing markets without undue pressure on household debt or house prices. We are much more optimistic in our prognosis for the Eurozone. We also suspect that the prospects for long term output growth are better than indicated by official projections. Our forecast would suggest that the prospects faced by a new government in May are not quite as dire as indicated by the OBR’s Budget arithmetic.
With the blanket media coverage of the General Election campaign in full swing, it may feel difficult at the moment for businesses to plan ahead for life after May 7th. But the fact is the ‘phoney war’ is drawing to a close, and politics has had only a limited impact to date on the UK’s economic prospects.
This EY ITEM Club Spring Forecast suggests the UK economy will weather the election storm in relatively good shape, with GDP growing 2.8% this year and CPI inflation averaging 0.1%, effectively taking base rate increases off the agenda until spring 2016. It also highlights that – barring major upsets in the election – favourable trends in commodity and export markets should outweigh the effects of political uncertainty.
Against this background, businesses now need to ensure they are fully prepared to get back to business on May 8th, and make the appropriate decisions once the General Election result is known.
This means seeking out areas of certainty to plan against. For example, whatever the election outcome, the rebalancing of the global economy will continue. As EY’s recent Capital Confidence Barometer showed, corporate confidence in the global economy is high, and actually running ahead of confidence in domestic economic prospects in most major economies. The improving outlook is most noticeable in the Eurozone, thanks to factors including lower oil prices, the impacts of quantitative easing (QE) on the exchange rate, and a more stable banking sector.
But it’s not just the Eurozone economy whose health appears to be improving, with sentiment in India picking up and the US continuing to grow steadily. EY’s latest CCB also points to a rebalancing in corporate investment priorities, with a pivot back towards developed markets. So now is the time for businesses to review their geographic portfolios.
A further area of relative certainty is that the election looks unlikely to dampen UK consumer spending. EY ITEM Club forecasts that household disposable income will grow by 3.7% in 2015, its fastest for over 20 years – a trend that should fuel higher spending by consumers. With recent strong retail sales data and car purchases suggesting the consumer recovery is becoming increasingly robust, businesses must put plans in place to capitalise on this rising spending.
As ever, there are concerns to take into account. Business investment has eased since the rapid growth in 2014, partly reflecting uncertainty over the election result. But the EY ITEM Club is forecasting that UK economic growth will remain healthy through to 2018, average just under 3% a year – a growth rate that will create opportunities for business. Exploiting this growth is likely to require investment, so business needs to ensure it has the capacity to invest.
Once the identity of the future government is known, companies can then work through the business implications of likely policy. Obvious potential differences include fiscal policy and the UK’s relationship with the EU. Moreover, whatever the composition of the new government, immigration policy is likely to impact business. Across all these areas, analysis and contingency planning will be needed to ensure there are no nasty shocks in store.