Outlook for financial services
EY ITEM Club
Omar Ali, Managing Partner, UK Financial Services, EY UK.
Inflation and pressure on real incomes in 2018 set to bite financial services before Brexit
Brexit and the future of the financial services industry in the UK after March 2019 are rightly priorities for the industry, but we can’t lose sight of the challenges the economy holds for financial services in 2018
A lot has changed in the UK in the last four months. The Government has triggered Article 50 and officially started the process of the UK leaving the European Union; we have had a general election, resulting in a Conservative minority Government; and the Brexit negotiations have now officially started.
Whilst we are still a long way from reaching a final agreement, these recent events have led many to hope we are heading towards a transitional period and a Brexit deal that avoids a cliff edge, and the latest EY ITEM Club forecast reflects this assumption.
As a result, the forecast for GDP growth in each year from 2017 to 2020 has been revised up slightly and this does have a positive impact for the outlook for financial services and their customers. The short-term economic outlook, however, still remains pretty challenging for consumers and, consequently, the financial services sector.
Inflation is now at a four year high and forecast to peak just above 3% in the autumn, which will squeeze household spending power. The EY ITEM Club predicts slow growth in wages and for real earnings to fall by 0.5% this year. Real household disposable income is forecast to fall by 0.2% this year, the first drop since 2013, which will compound the effect of inflation on consumers. As a result, growth in consumer spending is predicted to slow from 2.8% in 2016 to 1.9% this year and to 1% the next.
Households’ appetite to take on more debt has already shown signs of cooling in the recent months and this fall in disposable income is likely to compound that. Mortgage lending is forecast to fall by £8b in 2018 and, whilst consumer credit grew by 8% last year, hitting a nine year high, this growth rate is expected to fall to 5.4% in 2017 and an average of 2.7% between now and 2020.
The rates being offered on business loans remain incredibly competitive - the average interest rate on a new corporate loan was just under 2.4% in April compared with 2.8% 12 months earlier and almost 7% just before the financial crisis struck. Despite this, and the fact that the Bank of England’s corporate bond purchase scheme ended in April, business lending is expected to remain flat in 2018 and 2019.
In total, the forecast is for a slowdown in overall lending growth in 2018 and 2019. Mortgage lending is to fall this year and business lending will stagnate. Despite concerns about the rate of growth of certain parts of the consumer credit market – notably car finance, credit cards and personal loans – the irony is, this is the only category of lending that is expected to grow meaningfully over the next few years.
Another consequence of the squeeze on disposable income is that big ticket purchases are expected to drop off. The EY ITEM Club predicts that car registrations will drop from a record 2.69m in 2016 to 2.58m this year and 2.42m in 2018, whilst annual growth in housing transactions will average 2.6% from 2017 to 2019, compared with 7% in the previous five years.
This is bad news for general insurers as it means demand for non-life insurance products is set to fall. They already face significant policy headwinds from the rise in Insurance Premium Tax, the delay in legislation to reduce whiplash claims and the review into the Ogden discount rate. Whilst personal lines insurance looks like it has hit the bottom of the cycle in terms of pricing, which means that premiums in retail general insurance will be improving, we aren’t seeing rate increases on commercial lines, and the economic and policy environment looks difficult for General Insurance.
There are some sectors within the financial services industry which are set to have a good 2018. The relative health of the world economy and the depression in the value of sterling are helpful for life & pensions and asset management. The forecast is for renewed growth in equity markets and continued upward pressure on gilt yields - as of July, 10 year gilt yields were at 1.4%, double the level of last summer, and the forecast is for yields to increase to 2.5% between 2017-2020
Total UK assets under management amounted to almost £1.1t at the end of 2016, equivalent to 56% of UK GDP. Thanks to the forecast improvement in equities and gilts, the fact that the population continues to age, and increasing auto-enrolment rates, The EY ITEM Club expects assets under management (AUMs) to rise to £1.3t by 2020.
It’s not all bad news for the sector, but the enduring message for me from this forecast is that the next two to three years are looking more difficult for financial services than perhaps we had originally thought.
There’s been a lot of speculation about what will happen in the longer-term regarding Brexit and a transitional deal. That’s only right - given the importance of financial services to overall economic prosperity in the UK, it’s vital that the industry’s needs are front of mind during the Brexit negotiations. However, we can’t afford to lose sight of the short-term.
The return of inflation was always going to be challenging, especially since the sector has only relatively recently shaken off the effect of reduced consumer confidence after the financial crisis. Both mortgage, and businessending to a lesser degree, are expected to drop back next year. Falling real disposable incomes and policy headwinds will make 2018 a tough year for general insurers and there’s also a risk of consumer credit growing out of pace with affordability as people try to compensate for the impact of inflation. To put the industry in the best possible place to face the outcome of the Brexit negotiations, we need to keep our eyes on 2018 and 2019.