Brexit just one of the uncertainties impacting the UK economy as business investment suffers – EY ITEM Club Summer Forecast 2019

08 July 2019

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  • EY ITEM Club forecasts business investment to contract 1.6% in 2019
  • GDP growth projections maintained at 1.3% for 2019 and 1.5% for 2020

London Monday 8 July 2019: Despite a promising start to the year, business investment is expected to contract 1.6% in 2019 as prolonged Brexit uncertainty and a challenging global economy impact companies’ willingness to invest and commit to major new projects, according to EY ITEM Club’s Summer Forecast.

Business investment had a torrid 2018 when it fell 0.4%, following growth of 1.5% in 2017, and is expected to continue to struggle this year. The first quarter of 2019 saw business investment grow by 0.4%, but it was still down 1.5% year-on-year (y/y) and 2.2% below the peak level seen in the fourth quarter of 2017, and this is unlikely to have marked a decisive turning point, says the EY ITEM Club.

Mark Gregory, EY’s chief economist comments: “Three years after the Brexit vote, the UK economy is arguably more uncertain and unpredictable than it was in 2016. As various aspects of the economy react differently to the current situation it paints a confusing and conflicting picture for businesses. However, if the UK manages to leave the EU with a deal on 31 October it will provide some semblance of stability which could result in a pick-up in business investment. The unknown nature of the UK’s long-term relationship with the EU has the potential to limit this upturn though and the real worry is that we wake up in 2025 out of the EU and with a very uncompetitive economy.”

According to the EY ITEM Club, business investment is also likely to be lifted by some companies looking to invest in automation to make up for labour shortages and boost productivity. Furthermore, the recent extended weakness of business investment suggests that some companies have delayed replacing plant and equipment or investing in new processes, and this will eventually need to be addressed. Overall, the EY ITEM Club expects business investment to rise by 1.8% in 2020 but not at a level to allow any catch-up with the UK’s competitors.

GDP growth to remain tepid

The EY ITEM Club has maintained the GDP growth projections from its Spring Forecast, predicting 1.3% growth for 2019 and 1.5% for 2020. Growth in Q1 2019 came in at the top end of expectations at 0.5% q/q, but this was given a major lift by stockpiling amid concerns that a disruptive “no deal” Brexit could have occurred in late-March, says the EY ITEM Club. There appears to have been considerable payback in Q2 2019 and the EY ITEM Club suspects GDP contracted modestly (by 0.2% q/q).

Howard Archer, chief economic advisor to the EY ITEM Club comments: “An unwinding of the substantial stockpiling that occurred in Q1 2019 has clearly weighed on the UK economy in Q2, while it has also been hampered by extended Brexit uncertainties, an unsettled UK political situation and a challenging global economic environment. It also looks like consumers took a breather in Q2 after spending at a fair pace in Q1.

“We expect the economy to return to modest growth in Q3 with the upside being limited by ongoing uncertainty and lacklustre global growth, especially the slowdown in the eurozone, which is likely to hinder UK exports. However, there may be some renewed stockpiling around September/October by businesses and consumers in case a “no deal” Brexit occurs at the end of October.

“If the UK leaves the EU with a ‘deal’ on 31 October, we expect economic activity to gradually pick up. Consumer spending should benefit from lower inflation, although we suspect that real earnings growth in the near term may be lower than the peak levels seen in early-2019, while employment growth is expected to be slower.”

Global economic environment remains challenging and uncertain

The global economic situation remains largely unhelpful for UK growth prospects while providing a particularly challenging environment for UK exporters, says the EY ITEM Club.

Howard Archer adds: “Despite global GDP growth holding up a little better than-expected in the first quarter, the second quarter looks to have seen a clear loss of momentum while an escalation of trade tensions between the US and China has been a significant development. Hopefully, action by global policy makers through interest rate cuts and stimulus measures may provide support to economic activity going forward. We expect UK export growth to be a mediocre 1.5% in 2019, and net trade is expected to make a substantial negative contribution to UK GDP growth over the year.”

Lower economic growth if Brexit is delayed again or if there is ‘no-deal’

If Brexit is delayed beyond 31 October, there are likely to be adverse repercussions for the economy in the near term says the EY ITEM Club. Uncertainty facing businesses, in particular, and consumers would be extended, although sterling would likely remain softer for longer, which could have some modest positive impact on exports. Under this scenario, the EY ITEM Club expects that GDP growth would be limited to 1.3% in 2020, compared to the central forecast of 1.5%, before improving to 1.8% in 2021.

In the event of a ‘no-deal’ Brexit, the EY ITEM Club forecasts that GDP growth would slow from 1.3% in 2019 to 0.3% in 2020, with the economy possibly suffering mild recession over the first half of the year, before improving to 1.1% in 2021.

Bank of England likely to sit tight on interest rates through 2019

The EY ITEM Club believes it is highly likely that the Bank of England will keep interest rates on hold at 0.75% throughout 2019 and well into 2020. The EY ITEM Club does not expect the Bank of England to cut interest rates despite current heightened market expectations of such a move. On the assumption that the UK leaves the EU with a deal at the end of October and the economy subsequently shows some improvement, the EY ITEM Club expects the Bank of England to raise interest rates twice in 2020 (each time by 25 basis points) taking them up to 1.25% by the end of next year as it looks to gradually normalise monetary policy.

Businesses need to prepare for flux

Mark Gregory, EY’s chief economist, concludes: “Flexibility is the key word. Businesses need to base their plans on a low growth economy of around 1.3% but recognise that Brexit and the global environment all have the potential to create major shocks to activity at short notice. Businesses will need to avoid making knee-jerk reactions while also being able to shift course quickly if required. 

“In parallel, it will also be important for businesses to continue to plan for the prospect of a ‘no-deal’ Brexit situation. As we saw in the first quarter of 2019, there is a risk of an increase in stockpiling in the autumn if a ‘no-deal’ starts to appear likely. This could be even more challenging and disruptive as Christmas will place additional pressure on supply chains.”