Ernst & Young ITEM Club UK Winter Forecast 2013
The UK muddles through, with low growth the only certainty in 2013
A return to trend growth is still two years away
UK business sentiment and consumer confidence are at a low ebb and will take time to recover, and the ITEM Club believes that fiscal policy has not been as helpful as it could have been to this end. The government initially shied away from large cuts in current spending and went instead for large cuts in capital spending – despite their high GDP impact – and indirect tax increases – despite their high inflation impact. The Autumn Statement marked a modest reversal by adding £5bn (0.3% of GDP) to capital spending, but this addition is very small and the net effect on GDP is likely to be negligible. ITEM has consistently argued that the government should do more to encourage infrastructure and housing investment. Last year housing investment fell by 7%, subtracting 0.4% from GDP, whereas in the 1930s, the last period of consistently low interest rates, housing investment regularly added as much to GDP.
After a year or more of great uncertainty, ITEM believes the most likely outcome is that the UK will muddle through, staging a slow revival of activity as balance sheets, real wages and relative house prices continue to adjust. Growth in both domestic and overseas markets is likely to be subdued in the first half of the year, but ITEM expects to see stronger figures emerge in the second half, with GDP growing by 1.9% over 2014 and 2.5% in 2015.
UK consumer spending staged a modest recovery in 2012 as inflation fell back and employment growth picked up. Consumption increased by 1.3% on the year to the third quarter, after falling back by 1.5% over the previous year. The demand for durable goods was particularly impressive – up 12% on the year to the third quarter – reflecting price reductions, pent-up demand and the launch of new electronic products. At the same time, households responded to rising prices by scaling back consumption of food, drink and tobacco as well as gas and electricity.
The growth in UK employment continues to support consumption…
Although earnings growth lagged behind inflation, income from employment increased by 3.7% over the year to the third quarter, while the CPI increased by 2.6%. Including dividends, interest and rent, total income increased by 4.4% over this period. Employment in the private sector increased by 627,000 in the year to September 2012, dwarfing the fall of 128,000 in the public sector – a net gain just shy of a half million jobs. The switch from full-time to part-time work seen since the recession now appears to be reversing, and the numbers employed and the number of hours worked are back to their 2007 peaks, despite the lower level of output.
The forecast sees employment increasing by a further 244,000 this year and 280,000 in 2014. The growth in average earnings almost catches up with CPI inflation in 2013 and moves ahead in 2014. Real household disposable income increases by 1.2% this year and another 0.6% in 2014 while consumer spending increases by 1.1% and 2.0% respectively.
…while the outlook for housing gradually brightens
Rising real incomes and consumer confidence, supported by an increase in the supply of mortgages and a reduction in their cost, are positives for the housing market. The Bank of England’s December Credit Conditions Survey (CCS) showed that the Funding for Lending Scheme is providing a significant boost to the availability of mortgage and perhaps other forms of credit. The ITEM Club’s forecast sees housing transactions recovering further this year and moving up above the million mark next year. House prices are set to follow, increasing by 2.1% in 2014 and 5.0% in 2015, after marking time this year. Housing investment remains weak this year, but picks up by 5.6% next year and 6.1% in 2015.
Business investment has shown some improvement…
Growth in UK business investment remains modest compared with previous recoveries. It grew by 5.1% in the year to the third quarter of 2012, reaching £31.5 billon. This is 13.6% higher than the trough seen in Q4 2009, though 11.6% lower than the peak of Q4 2007. But perhaps this should be seen as encouraging given the huge risks then facing European and other overseas markets. Business spending should pick up as these uncertainties are resolved and risk aversion abates, helped by the very strong cash flows and balance sheets enjoyed by UK plc. The CCS tentatively points to an increase in funding, particularly for medium- and large-sized companies. ITEM sees investment growing by 3.1% in 2013 and 8.1% in 2014.
…and exports should begin to grow this year
UK export volumes were probably flat last year, with modest growth in exports of goods offset by a fall in exports of services. Exports of goods to the EU fell by 7.2% in the year to the third quarter, with particularly sharp falls in shipments to Spain, Italy, Germany, Belgium and Sweden. Deliveries to the US and China were up by 6.3% and 7.6% respectively, but failed to compensate. Although world economic prospects remain fragile, ITEM expects overseas markets to strengthen, boosting world trade by 3.8% this year and by 6.2% in 2014. The forecast shows UK export volumes increasing by 3.1% this year, 5.1% in 2014, and nearing 7% in 2015 and 2016. Net trade makes a negligible contribution to GDP this year, but its contribution builds up to 0.5% of GDP by 2016.
For detailed projections, see the table on the Forecast headlines and projections page.