EY ITEM Club UK Winter forecast

Consumers’ ‘holiday’ to be extended until 2016.

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Forecast in summary

by Peter Spencer, Chief Economic Advisor, EY ITEM Club

The New Year brought several stark reminders of the fragile global situation. Yet, the UK is relatively well placed to ride out these storms. We see growth picking up from a downwardly-revised 2.2% in 2015 to 2.6% this year, supported by low inflation and interest rates. The CPI is forecast to increase by just 0.7% and we do not expect the MPC to increase bank rate until November.

The UK consumer had a welcome holiday from inflation and austerity in 2015, and given the recent plunge in oil and other commodity prices and the Chancellor’s change of heart on working tax credits, we expect this to continue well into 2016. Last year, consumption lagged the increase in real incomes, but this year we expect consumption to increase by another 2.8%, just behind an increase in real incomes of 3%. Strength in the housing market should also support spending, increasing both housing transactions and investment.

But inflation and austerity will return in 2017, slowing the GDP growth rate to 2.3% and then to 2.2% in 2018. The changes to the welfare budget in the Autumn Statement and the new plans for departmental spending will add £6.2b to government borrowing in 2016-17. Yet the Chancellor’s has stuck to his plan for a financial surplus in 2019-20. Taxes and levies on consumers and companies are going up and the roll-out of Universal Credit will claw back this Autumn’s concessions to low earners.

Low inflation and interest rates are helping the Chancellor, but reflect the risky global outlook which may yet impact the UK and the fiscal figures. More realistic OBR revenue models also help, but leave a smaller cushion should this sort of risk materialise.

Uncertainty over the EU Referendum could hit business investment this year as firms wait to see the outcome. However, the momentum in the UK as well as US and European economies should be enough to underpin capital spending this year. Lower energy and higher labour costs also favour plant and machinery at the expense of labour. Companies are in a good position financially to expand capacity in this way.

The revival of our traditional export markets has so far compensated for the fall in exports to Emerging Markets. The revival of these markets is also steadily repairing the damage to our overseas investment income account which has which has been primarily responsible for the increase in the current deficit in recent years. This narrowed from a deficit of £11.2b in the final quarter of 2014 to £3.1b in the third quarter of 2015 and we expect further improvement over the period of the forecast.

Business implications

by Mark Gregory, EY Chief Economist

It is time to balance ambition…

The global economy remains dynamic and uncertain. Now is the time to review existing plans and business models, giving priority to:

Geographic focus: with the outlook for emerging markets remaining challenging, UK corporates should review their portfolios to ensure they are giving adequate focus to the improving economic prospects in the developed world (i.e. US and the EU).

Understanding the changing consumer landscape: consumer spending is expected to remain strong but levels of income growth are likely to vary by segment. The National Living Wage will mainly benefit lower earners whereas mid-income employees may see technology eroding their bargaining power. Understanding the variations will be crucial and our February EY ITEM Club consumer spending special report will be a helpful resource.

Margins: are likely to come under increasing pressure with the introduction of the National Living Wage, increasing average earnings and an eventual interest rate rise. Businesses should review their business models and ensure their investment plans incorporate sufficient resources to drive productivity enhancing change.

UK regions: The UK Government has embarked on a programme to devolve economic decision-making power to the UK regions. This will create new opportunities and our recent report on the UK region and city economic forecast is a good starting point for understanding these.

…with risk management

While EY ITEM Club believe the UK is well placed to ride out the global storm, there are obvious risks to this view and hence a clear risk management plan should be high on the corporate agenda. Key areas to focus on are:

China: the impact of a significant slowdown -which would impact both commodity and trade activity.

Geo-political risk: if there was an unexpected spike in oil prices for example, this would impact net importers of oil, such as the US and the Eurozone, not as directly exposed to the China risk.

Currencies: likely to remain hard to forecast in this complex global economy.

UK domestic activity: could slow and the Government could easily find its finances under strain.

Brexit: will loom ever larger in 2016

Contact

EY - Mark Gregory

Mark Gregory

EY Chief Economist