Stronger global economy paves the way to Brexit says EY ITEM Club

10 April 2017

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  • GDP for 2017 expected to reach 1.8%, a similar outturn to last year, but the makeup of growth will be very different
  • Trade forecast to add 0.2% to GDP this year and 0.6% next year
  • But political developments could still derail the improving global picture

A revival in the UK’s overseas markets will support the economy’s readjustment away from consumer spending towards trade and help smooth the impact of Brexit on GDP, according to the EY ITEM Club spring forecast.

The EY ITEM Club says that while consumer spending provided all of the UK’s growth last year while overseas trade subtracted 0.4% from GDP, the balance of economic activity in 2017 will be different. The falling pound since last year’s referendum is contributing to rising inflation, which is expected to reach 3% this summer. Resulting pressure on households’ incomes means that growth in consumer spending is due to slow, but the pound’s drop, along with increasing evidence of momentum in the UK’s major international trading partners, is expected to spur growth in exports of 6.7% in 2017 and 5.3% in 2018. Overall, net trade is forecast to add 0.2% to GDP this year and another 0.6% in 2018.

As a result of support from a stronger global economy, the EY ITEM Club says that GDP growth will reach 1.8% this year (up from 1.3% in its previous forecast), 1.2% in 2018 (from 1%) and 1.5% in 2019 (from 1.4%). The EY ITEM Club says that the MPC is likely to hold Bank Rate at its current 0.25% until the autumn of 2018.

Economy adjusting to life outside the EU

Peter Spencer, chief economic advisor to the EY ITEM Club, comments: “Although the starting gun for Brexit has just been fired, the UK economy has been adjusting to life outside the EU since the referendum. Recent data suggest that the pound’s depreciation has boosted manufacturing, while inflation has subdued retail sales growth.

“At the same time, unlike 2008 when the pound last had a big fall, we are now selling into buoyant markets. Growth in world trade, which has been in the doldrums for several years, is now stronger than at any time since the initial bounce-back from the recession in 2010. This will be a big help in offsetting the headwinds from weaker consumer spending.”

Business investment is the missing piece of economy’s rebalancing

The EY ITEM Club forecast says that with growth in consumer spending forecast to slow to 2% in 2017 (down from 2.8% in 2016), subdued levels of business investment could put the UK economy’s rebalancing at risk in the long term despite a rise in exports. The forecast expects investment by businesses to drop by 2.2% in 2017 and a further 1.5% in 2018.

Peter Spencer adds: “With unfettered access to the single market for now and a weaker pound, exporters are currently enjoying the best of both worlds. However, investment in new export capacity and the UK supply chain will be necessary to extend the recent strong performance of overseas sales after the UK has left the EU.

“The need for more investment in education, skills and labour saving machinery is also crucial as European immigrants have provided much of the extra labour employed by UK business in recent years. However, the required spending by firms is unlikely until details of the new trading arrangements and immigration controls become clear.”

Mark Gregory, EY Chief Economist, adds: “The shape of the UK economy is changing now and businesses that focus unduly on Brexit risk being caught out. The trends are becoming clearer and there is a need for businesses to reevaluate the balance of activity between domestic and international markets.

“Investment in capacity and skills is clearly going to be critical if the UK is to succeed in a competitive global market. Business has a key role to play here but so does the Government. Collaboration will be essential.”

Could international developments upset the applecart?

Peter Spencer concludes: “The global and UK outlook remain at risk from political developments most notably in the US and Eurozone. The financial markets welcomed the US administration, but recent episodes demonstrate that the timing and magnitude of US policy initiatives poses a degree of uncertainty. The upside in the guise of tax reform, deregulation and infrastructure spending has the potential to boost the US and world economies. The downside from the threat of barriers to international trade and tougher immigration controls, however, could pose challenges as the UK adjusts to Brexit.

“The UK’s trade performance and output growth in 2019 and beyond will also depend critically upon the exit terms that can be agreed with the EU 27 and other countries. Our central case is based on the assumption that UK-EU trade will be conducted under World Trade Organization rules, however there the is potential for an upside surprise if  transitional arrangements can be put in place, perhaps followed by a Free Trade Agreement later.”

Read the full Spring forecast from Peter Spencer, Mark Gregory and Julie Carlyle