UK economy faces short, sharp shock, but exports offer silver lining says EY ITEM Club

18 July 2016

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  • The EY ITEM Club has revised its GDP growth forecast for this year down from 2.3% to 1.9% and from 2.6% to 0.4% in 2017
  • Brexit uncertainty will hold back consumer spending and business investment, resulting in a rise in unemployment
  • Exports are likely to be the silver lining in the Brexit cloud, boosted by a weaker pound 

The UK economy, post-referendum, will take a very different path to the one expected three months ago. While the fundamentals will not change in the short term, there are likely to be severe confidence effects on spending and business investment, resulting in anemic GDP growth for at least the next three years, according to the EY ITEM Club summer forecast.

The post-referendum fall in the pound should cushion the economy against some of the adverse effects of uncertainty by boosting UK exports. By the end of the year the EY ITEM Club expects sterling’s trade-weighted value to be 15% down on the level in Q4 2015. However, this will not be enough to prevent a significant deterioration in the UK’s growth outlook, compared to the predictions the EY ITEM Club made in April.

The EY ITEM Club is forecasting GDP growth of 1.9% this year (down from the 2.3% it predicted in April) and expects growth of just 0.4% in 2017 (down from 2.6%) and 1.4% in 2018 (down from 2.4%). Business investment is expected to see a larger relative hit, falling by 0.9% in 2016 and by 2% in 2017 – down from April’s forecast of growth of 3.2% and 7.8% respectively.

The EY ITEM Club believes that the longer-term outlook for the economy will be determined both by domestic policies in areas like regulation and by the UK’s ability to secure trade deals with the EU and other markets. The forecast assumes that post-2019 the UK will be able to negotiate a free trade agreement with the EU similar to the recent EU-Canada deal, which keeps trade between the UK and the EU free of tariffs.

Uncertain outlook brings anemic growth

Peter Spencer, chief economic advisor to the EY ITEM Club, comments: “The economy is set to suffer a severe loss of momentum in the second half of this year. Heightened uncertainty is likely to hold back business investment, while consumer spending will be restrained by a weaker jobs market and higher inflation. Longer-term, the UK may have to adjust to a permanent reduction in the size of the economy, compared to the trend that seemed possible prior to the vote. But amongst the gloom, the weaker pound provides one silver lining to exporters, particularly those selling to the US and emerging markets.”

Steve Varley, EY’s UK Chairman, adds: “Undoubtedly the next couple of years will be challenging for the UK economy. The UK government will need to quickly introduce measures to help offset Brexit blues, support the economy and continue to attract foreign investment.

“While investors value the UK’s access to the single market, we shouldn’t lose sight that they also rate the UK’s quality of life, diversity and culture, education, stability of social climate, telecommunications, and labour skills highly. These underlying fundamentals have not changed.

“The focus now needs to be on making sure that the UK negotiates the right trade deals that will allow access to key markets. There are numerous opportunities for the economy to remain not only open for business but also attractive, competitive and connected.  As the world’s fifth largest economy, the UK will continue to be an integral piece of the global jigsaw.”

Consumer won’t be left unscathed

The aftermath of the EU referendum result may deliver some positive news for consumers in the form of lower interest rates. However, heightened uncertainty, higher inflation and a weaker jobs market point to a gloomier overall outlook, according to the EY ITEM Club.

The EY ITEM Club expects the Monetary Policy Committee (MPC) to cut interest rates to zero by November but says that inflation is likely to rise above 2% by the end of this year, averaging 2.5% in 2017, before slowing to 1.6% in 2018.

The forecast sees unemployment rising from 5% currently to 7.1% by the end of 2019. This will have a knock-on impact on household real disposable income, which is forecast to fall by 0.5% in 2017. Consumer spending is expected to increase by 2.2% this year but then drop by 0.6% in 2017, the first decline since 2011.

Peter Spencer continues: “Consumers have for some time now punched above their weight in driving the economy’s expansion. However, worries about jobs are likely to see shoppers hold back on big ticket purchases, such as cars and housing-related spending. At the same time, higher inflation off the back of sterling’s weakness will squeeze growth in real incomes.

Exports are a bright spot

Reflecting the fall in the pound and the weakness in domestic demand, the EY ITEM Club predicts that exports will increase by 3.4% in 2017 while imports will fall by 0.3%. Consequently, the forecast expects net exports to add 1.1% to GDP next year, the strongest contribution from this source in six years.

Peter Spencer adds: “The UK is uniquely placed in exporting services and enjoys a reputation for high value added pharmaceuticals, designer-label and branded consumer products. As high growth emerging markets move away from investment towards consumption, UK exporters need to focus their energies on seizing the benefits that this switch creates.”

Opportunities post the initial shock

Peter Spencer concludes: “It is vital that policy makers respond positively to the challenges and opportunities that lie ahead. Short-term, while we still have full access to the single market, the fall in the exchange rate will provide opportunities, while the predicted increase in inflation and unemployment will help to rebalance the economy away from consumption.

“In the longer term, if the UK does lose unfettered access to the single market, the need to offset the damage will make it vitally important for the UK government to use its new-found freedoms over areas like trade and regulation successfully.”