EY ITEM Club
Spring forecast

Will the global economy help
pave the way to Brexit?

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EY have been sole sponsors of the ITEM Club for 25 years. It is the only non-governmental forecasting group to use HM Treasury's model of the UK economy. Our reports provide a detailed economic analysis and forecast of economic activity for the period ahead. They are independent of any political, economic or business bias.

Forecast highlights

by Peter Spencer, Chief Economic Advisor, EY ITEM Club

The economy is already adjusting to life post-Brexit…

Our forecast projects that UK GDP will grow by 1.8% this year, in line with last year’s outcome. However, this doesn’t mean that nothing has changed in the economy. In fact, it masks an underlying shift in the balance of demand following the fall in the pound after last June’s Brexit vote – and means the economy is already adjusting to life outside the EU.

We also expect growth to slow down during the course of this year, leaving 2018 and 2019 looking weaker at growth rates of 1.2% and 1.5% respectively.

…as consumption slows…

The shift in demand that’s underway essentially involves a rebalancing from consumption to overseas trade. Last year, consumption effectively accounted for all the growth in demand, with overseas trade subtracting 0.4% from UK GDP growth. But with the savings ratio at a record low, this year sees a major slowdown in consumption as inflation bites into spending power. Meanwhile, net trade is projected to add to GDP in every year covered by this forecast.

…and overseas markets come to the rescue

This adjustment is being helped by a timely revival in our overseas markets. World trade and industrial output are growing faster than at any time since 2010, when they bounced back from the recession. For once, the recent economic data has surprised on the upside – not just in the UK but also in the US and Eurozone.

This revival partly reflects the knock-on effects of the collapse in commodity prices in 2015. And their recent recovery has pushed inflation back close to target levels almost everywhere, easing worries about deflation, especially in the Eurozone.

Despite the bright spots, political risks remain…

However, the global outlook remains at risk from political developments. In the US, the ‘Trump bump’ in the financial markets has been followed by another increase in consumer and business confidence. As a result, consumer confidence there is now stronger than at any time since the dot-com boom in 2000. However, as president, Donald Trump is facing political challenges in delivering some of his campaign promises – a situation that makes the likelihood, timing and magnitude of US policy initiatives very uncertain. What’s more, any initiatives he does succeed in delivering could either help or hinder the UK’s adjustment to life outside the EU.

…as the UK weighs up its options

Against this mixed background, UK exporters are currently enjoying the benefits of Single Market membership as well as the devaluation in sterling and the revival in the world economy. We are assuming they will be trading under WTO rules in two years’ time, although it’s possible that the Government will be able to negotiate more favourable transition arrangements, perhaps followed by free trade agreements. These arrangements would make the adjustment smoother than the WTO option and provide some upside potential.

Time to invest in export capacity

But whatever happens with the UK’s trading arrangements in the next few years, there’s a clear and urgent need for investment in new export capacity and the UK supply chain to help businesses adjust to leaving the EU and the economy to rebalance. Moreover, European immigrants have provided much of the extra labour employed by UK business in recent years, a contribution that made shortages of skilled labour a thing of the past.

There have been anecdotal reports that some may have already left the UK, potentially leaving gaps in UK production facilities, and underlining the pressing need for more investment in education, skills and labour-saving machinery.

However, many firms may not have the confidence to invest until they see the shape of the new trading and immigration arrangements. The forecast sees investment falling this year and again in 2018, holding back demand and longer-term economic performance. As the countdown to Brexit begins, it’s clear that UK businesses will be living with uncertainty for some time to come.

Look beyond the headlines...

by Mark Gregory, EY Chief Economist

The EY ITEM Club Spring forecast shows UK GDP growth of 1.8% this year, in line with 2016. At first glance, this might seem to suggest that it’s “steady-as-she-goes” for the UK economy – an impression that was strengthened by the markets’ muted reaction to the UK’s decision to invoke Article 50. Indeed, the overall mood suggests that there’s no urgent need for businesses to act.

...because the UK economy is changing...

However, as ever, appearances can be deceptive. The change in the UK economy highlighted in the EY ITEM Club Winter forecast is becoming clearer – with the similar headline growth rates for 2016 and 2017 masking a shift in the balance of demand, as the fall in the sterling exchange rate following the Brexit vote feeds through the system.

So the UK economy is already adjusting to a future outside the EU, as the domestic outlook weakens while export growth strengthens. And as well as the balance of the economy changing, the forecast also sees overall growth gradually slowing through to 2018, with GDP growth of 1.2% and 1.5% for 2018 and 2019 respectively.

...with slowing domestic demand...

These effects are already clear in the retail sales figures. As predicted in the recent EY ITEM Club Special report, consumer spending is slowing down as inflation and other headwinds sap spending power. The rise in retail sales volumes in February was the first increase since last October, but on a three-month-on-three-month basis sales were down by 1.4%, the weakest performance since March 2010. And unless there’s an unprecedented rebound in March, the first quarter of this year will deliver the first quarterly retail sales contraction since 2013.

...but faster global growth

This relatively sombre picture at home has been offset by more positive news in recent months from the major economies of China, the US and the Eurozone.

  • Back in 2015, China was at the centre of global concerns, amid worries that a financial crisis there would hit the main engine of world trade. While worries about China persist, the authorities seem to have a grip on the situation.
  • The financial markets welcomed the new US administration, with the stock market hitting new highs. This ‘Trump bump’ has been echoed in consumer and business – especially small business – confidence.
  • Economic activity has picked up in the Eurozone, which in 2017 could record its strongest GDP growth since the Eurozone crisis.

All of this has seen growth in world industrial production rise to its fastest pace in seven years, at a time when the recovery in commodity prices is boosting many emerging markets. So the overall outlook is for stronger global growth than we’ve seen in the last couple of years.

Businesses need to review their plans now…

As I’ve mentioned before, the UK economy has performed better since the EU referendum than many economists had forecast. Combined with uncertainty over the upcoming negotiations between the UK and EU, this has created a "wait-and-see" mind-set among businesses.

This cautious approach was initially justified by uncertainty over the ultimate shape of Brexit. However, the changes underway in the UK economy show that the decision to leave the EU is already having an impact, meaning waiting is no longer the best option. Crucially, there’s a clear need to revisit the balance of resources between domestic and external activities.

...shoring up domestic activities...

While it may be difficult to generate support for capital investment in a slowing domestic market, the changing economy means action is imperative. Immigrants from continental Europe have provided much of the extra labour employed by UK businesses in recent years, but many are now going home following the referendum vote and subsequent fall in the pound.

This could be a major headache for employers over the next few years, reinforcing the need for more investment in education, skills and training – and potentially in robots and other labour-saving machinery as well.

...moving to exploit emerging opportunities…

On the upside, the global outlook is improving and the UK Government has clearly stated its desire to make the UK more successful in the world economy. So investment will be needed not only to strengthen the domestic supply chain but also to build new export capacity. While internationally-oriented investment always brings risks, faster global growth and the UK Government’s strong desire to sign new trade deals means it’s important to start analysing the opportunities now.

…and ensuring Government plays its part

Investment in capacity and skills will clearly be critical if the UK is to succeed in a competitive global market. While business has a key role to play here, so does the Government. Infrastructure can help unlock investment and skills, so the industrial strategy is key to ensuring an integrated approach to repositioning the UK for life after Brexit. And business must work with the public sector to identify priority actions and establish how these can generate the biggest economic benefits. Put simply, the UK’s post-Brexit economy is already taking shape – and business must be ready for it.

Driving long-term value in retail: weathering the perfect storm

by Julie Carlyle
Partner and Head of Retail, UK and Ireland

The EY ITEM Club’s spring forecast highlights a rich blend of developments including ongoing changes in the UK economy, slowing domestic demand as the UK consumer wallet shrinks, a rebound in global growth, and intensifying pressure on efforts to secure the right labour force. Faced with the combined impact of these trends, retailers have some big questions to ask themselves when looking at ways to sustain the long-term value in their business.

I previously commented on EY ITEM Club’s special report on consumer spending that a perfect storm is brewing for UK retailers as the margin vice tightens, with myriad pressures coming in from all sides. Navigating through this storm will require retailers to take some significant strategic and operational decisions, as well as answering a number of critical questions around the consumer.

Against this challenging background, retailers need to take a closer look at three areas:

  • Your international footprint
    This is not a new challenge for retail businesses. But it’s one that becomes far more pertinent when the balance of opportunity tips towards the export market - especially when the geographical structure of your supply chain and distribution network is being called into question by both currency impacts and the potential effects of Brexit on trade routes and movement of goods. From a market perspective, retailers are now looking to expand the footprint of their brand rather than that of their physical network - because their brand is where the real value lies.
  • The alignment of talent, productivity and innovation
    There has been a strong focus on increasing labour costs in retail in recent times - exacerbated by the further increase in the National Living Wage to £7.50 that came into place on April 6th and the introduction of the Apprenticeship Levy. However, the risks around non-UK labour are key for retailers, not only across physical stores but also in distribution and fulfilment centres. The resulting labour force pressures could accelerate the need to innovate and automate, and to integrate previously siloed business models. That said, talent development will also rise up the agenda as the war for this talent intensifies, and as it becomes more vital to have the right people undertaking changing roles and meeting the ever-rising expectations of customers. As a result, the value to your business of employee engagement - as well as consumer engagement - will undergo a step-change to a new level.
  • The importance of focusing on the customer - remind yourself of the important questions asked recently in EY ITEM Club’s special report on consumer spending around successful consumer strategies:
    • a) How can you seize your share of the shrinking consumer wallet? The solution lies in delivering the right experience and being ready to disrupt your own business.
    • b) What type of sales are you looking for? In general, there is a rising focus on securing profitable sales rather than volume.
    • c) Who do you want to be your customer? Follow the money across demographics - and perhaps across borders and out of the country.

How will you weather the storm? Download EY ITEM Club’s spring forecast report for further economic insights.

 

Contact

EY - Mark Gregory

Mark Gregory

EY Chief Economist

EY - Julie Carlyle

Julie Carlyle

Partner and Head of Retail