No boom in consumer spending as workers face a lost decade of real wage growth says EY ITEM Club report

29 September 2014

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  • Real take-home pay will still lag behind pre-crisis levels in 2017
  • No respite for the “squeezed middle” and the young will suffer
  • Slow growth in overall consumer spending, but an increase in discretionary purchases

Real take-home pay will still lag behind pre-crisis levels in 2017 says a new special report on consumer spending released today by the EY ITEM Club. Households are facing a lost decade of real wage growth which will mean consumer spending growth will be low by historic standards. Consumer oriented businesses are facing a challenging environment.

EY ITEM Club believes the supply of workers will continue to grow at a robust rate. Even though the employment rate has already exceeded its pre-crisis peak, the report says that strong growth in employment will continue. As a consequence, it is likely that annual wage growth over the next three years will remain well below the 4.5%-5% rates typical before the crisis.

This will lead to a slowdown in the pace of consumer spending growth, which is only expected to increase by just over 2% next year and in 2016. This is a significant reduction on the average annual growth rate of 3.7% seen in the pre-crisis decade.

Martin Beck, senior economic advisor to the EY ITEM Club, comments: “Total household incomes have strengthened because more people are in work but individuals do not have extra money in their pockets. Real wages are being held back by strong growth in the supply of workers and the fact that firms are facing increased non-wage costs, such as new pension schemes. We expect this trend to continue for several years to come and it will be mirrored with a slowdown in consumer spending growth.”

No respite for the ‘squeezed middle’

According to the report, competition for high-skilled workers means this group will enjoy the traditional returns associated with growth and innovation while those with the weakest earnings potential will be supported by changes to the minimum wage and tax allowances. However the ‘squeezed middle’ looks set to be in that position for some time to come, seeing spending power improve more slowly than their higher and lower-paid peers.

The outlook for incomes also differs across age groups. The EY ITEM Club says spending power for those in their 20s and 30s will continue to be squeezed by an unemployment rate well above the average and the need to save for larger deposits for house purchases in a continuously rising market.

On the other side of the coin, the triple lock guarantee on state pensions and increased participation in the labour market will benefit those aged above 65. The UK has already seen a surge in older workers, with the number of people over 65 in work now standing at around 1.1 million, 60% up on the level at the beginning of 2008.

Beck adds: “Over the next few years our expectation is that the winners in the income wars will be older households while the young will continue to face significant obstacles to a decent rise in disposable incomes. The “squeezed middle” is also going to continue to struggle, as limited growth in disposable incomes, reflecting weak pay rises and the threat of jobs being automated, leaves them no choice but to remain frugal with their spending in the near future.”

Consumers will increase discretionary spending

Although the recent boom in some large ticket purchases such as cars, furniture and household appliances is cooling, consumers have begun to start spending more on other discretionary, non-essential goods and services. This pattern is likely to continue even though consumer spending is expected to rise at fairly modest rates during the next couple of years.

EY ITEM Club expects the winners of this increase in discretionary spending to be hotels, restaurants and consumer technology. It forecasts that annual growth in spending on recreation & culture, including TVs and audio visual equipment, will jump from an average of 1.7%, between 2008 and 2013, to 5.1% this year and 5.4% next.

Similarly, communications spending is forecast to increase by 4.5% in 2014, before peaking at 5% next year, reflecting further advances in the smartphone revolution. This is up significantly from the 0.3% annual growth averaged since 2008. The spending growth on consumer technology reflects not just a recovery in spending power but also rapid advancements in technology that have driven consumer demand for the latest products, such as wearable devices.

The ‘losers’ on the other hand are likely to include alcohol and tobacco, spending on which is set to drop by -2.6% this year and -1.2% in 2015, while education is expected to remain flat in 2015 and fall by -0.5% in 2016.

Julie Carlyle, Head of Retail at EY, states: “The squeeze on household incomes during and after the financial crisis was reflected in our spending habits but, as the economic expansion becomes more entrenched and incomes slowly strengthen, consumers are going to start treating themselves again.”

Consumer will be more frugal on food spending

The EY ITEM Club forecast suggests the outlook for food retailers will remain challenging. Consumer spending on food and non-alcoholic drinks is forecast to grow more slowly than consumer spending overall, with growth averaging 1.5% per annum over the next five years.

Carlyle concludes: “The upturn in the economy alone is not going to restore the fortunes of the retailers. Instead new business models, better reflecting changing consumer shopping habits, need to be embraced. More than ever before consumers are looking for real value for money and retailers need to recognise this in order to convert increased spending into profits.”