UK economy over the worst, but struggling to accelerate


02-03-2018

The UK economy is over the worst but is struggling to accelerate compared to its global counterparts, and will remain stuck in the middle lane in 2018 and over the medium term, says the latest forecast from the EY ITEM Club.

The EY ITEM Club’s Winter Forecast notes that UK GDP growth in 2017 was 1.8%, which was better than widely expected, however it nevertheless compares unfavourably with 2017 GDP growth of 2.5% for the Eurozone, 2.3% for the US and an estimated 3.0% globally.

The momentum from 2017, an improving outlook for consumer spending, and the increased likelihood of a near-term Brexit transition arrangement are expected to support UK growth this year. EY ITEM Club has nudged up its UK GDP forecasts for 2018 to 1.7%, up from the 1.4% it was predicting in its Autumn Forecast in October last year. However, further out, the UK’s limited productivity performance and ongoing Brexit and political uncertainties will see the UK achieve only ‘mid-range growth’. EY ITEM Club has slightly reduced its GDP growth projections for 2019 to 1.7% (down from 1.8%), 1.9% for 2020 (down from 2.0%), and 2.0% for 2021 (down from 2.2%).

Howard Archer, chief economic advisor to the EY ITEM Club comments: “The near-term prospects for the UK economy appear brighter, with GDP growth in 2018 being helped by the squeeze on consumers easing as the year progresses. We expect inflation to fall back from 3.0% in December 2017 to close to 2.0% by the end of the year as the impact of sterling’s past weakness fades. Meanwhile, earnings growth looks likely to pick up modestly during 2018. UK growth should be helped by exports benefiting from robust global expansion and a still competitive pound.

“However, it’s not time to crack open the champagne just yet. Brexit uncertainties remain significant while the squeeze on consumers remains appreciable at the start of 2018.  If a Brexit transition arrangement can be agreed early on in 2018, this would likely provide a boost to investment prospects over the year. Nevertheless, there will still be major uncertainties over the longer-term trade relationship between the UK and EU which will likely limit the upside for investment.”

The EY ITEM Club has modestly downgraded its expectation of the UK’s productivity performance, although it remains more optimistic than the Office for Budget Responsibility’s latest forecast. An improvement over the second half of last year also fuels belief there has been an appreciable cyclical element to UK productivity and that there is scope for a rebound over the medium term. Specifically, EY ITEM Club forecasts output per hour to rise 0.9% in 2018 and then 1.3% annually during 2019-2021.

Pressure on consumers to ease

The squeeze on consumers remains appreciable at the start of 2018 but it looks set to ease as the year progresses, which should provide increasing support to consumer spending. The EY ITEM Club estimates that consumer spending growth more than halved in 2017 at 1.4%, from 2.9% in 2016. It is then forecast to drop further in 2018 to 1.3% before improving to 1.6% in 2019.

The EY ITEM Club forecasts earnings growth to pick up modestly in 2018 as a consequence of recruitment challenges in a number of sectors and higher inflation fuelling some increased pay awards. However, the EY ITEM Club expects consumer price inflation to fall back close to 2.0% by the end of 2018, and it will likely dip below 2.0% during 2019.

The report forecasts employment growth to be subdued in 2018 despite a pick up at the end of 2017 following some softer data in the third quarter. The EY ITEM Club forecasts employment to rise at a reduced rate of 0.5% in 2018, with the unemployment rate edging up from 4.3% at the end of 2017 to 4.5% at the end of 2018, and 4.6% by mid-2019.

Two interest rate hikes forecast for 2018

With the economy now seemingly on a modestly firmer footing, a challenging labour market, inflation markedly above its target level and interest rates of just 0.5% still marking an emergency rate, the EY ITEM Club says that the Bank of England will move further towards normalising monetary policy. When raising interest rates in November last year, the Bank of England made clear that further tightening in monetary policy would take place gradually. The EY ITEM Club now expects the Bank of England to raise interest rates twice in 2018 rather than just once, from 0.50% to 0.75% in May followed by a further increase to 1.0% in November. One further increase to 1.25% is expected in 2019.

Business investment set to rise

Business investment expanded in each of the first three quarters of 2017 despite survey evidence indicating that some companies were delaying or reducing investment until there was more clarity on what would happen with Brexit.

With a transition agreement likely to be agreed in the first half of 2018, current trading and operating conditions for UK companies are set to be maintained until at least December 2020. Consequently, the EY ITEM Club expects business investment to rise 1.9% in 2018 after an estimated increase of 2.3% in 2017. Investment growth is then forecast to pick up to 2.7% in 2019, aided by improved economic activity. However, in the event of a transition agreement not being agreed, there is a strong risk of slower or worse progress in terms of business investment.

Mark Gregory, EY’s chief economist comments: “The UK economy is stable but unlikely to provide much support to growth for the next few years. UK businesses need to ensure that they are doing all they can to benefit from the most balanced, strong global growth for a decade. At the same time, while ensuring risks are identified and managed in the UK, now is the time to develop a post-Brexit business strategy identifying where future value will be created.”

 

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