The recent slump in sterling should prompt a significant readjustment of the UK economy away from consumer spending towards exports, according to the EY ITEM Club winter forecast. But while economic growth will be better balanced it is also likely to be slower.
UK economy set for a ‘hard rebalancing’ says EY ITEM Club
- EY ITEM Club is more optimistic about GDP growth in 2017, raising its forecast to 1.3% this year
- However, 2018 looks like to be a tougher year, with growth forecast to slow to 1%
- Exports provide the silver lining and are expected to increase by 3.3% this year and 5.2% in 2018
The EY ITEM Club says that the impact of sterling in increasing import costs will see inflation rise to 3.1% by the final quarter of 2017, before easing back to 2% by the end of 2018. This is expected to have a knock on impact on consumer spending, as growth in disposable incomes is eroded. However, the weak pound and a softer domestic market are likely to encourage higher levels of UK exports, as businesses seek income opportunities overseas, resulting in exports increasing by 3.3% this year and 5.2% in 2018.
According to the report, this rebalancing of economic activity will be accompanied by three years of relatively slow growth. The EY ITEM Club expects GDP growth to reach 1.3% in 2017 (up from the 0.8% it predicted in October’s forecast, but down from an expected 2% in 2016) and just 1% in 2018. The MPC is predicted to hold interest rates at their current 0.25% until the spring of 2018.
Economic impact of Brexit ‘shallow but prolonged’
Peter Spencer, chief economic advisor to the EY ITEM Club, comments: “We now expect the impact of Brexit on the UK economy to be shallower, but more prolonged than we did in October. However, there is a sea change coming over the next three years. The fall in the pound will force the economy to be less reliant on consumer spending, leaving growth heavily dependent upon trade performance.”
Nick Gomer, Office Managing Partner at EY in Cambridge, adds: “Whatever the outcome of the Brexit negotiations, there are clear indications that the fall in the pound and the UK’s exit from the EU will entail a change in the structure of the UK economy. The onus will be on businesses to adapt to the slowing domestic economy by seeking opportunities overseas.”
Headwinds facing the consumer pick up again
The EY ITEM Club forecast says that 2017 will see a progressive slowdown in consumer spending as the engine of employment growth stalls and inflation accelerates, squeezing household incomes.
After increasing by 1.8% in 2015 and 1.4% last year, employment is forecast to rise by just 0.2% in 2017, fall by 0.2% in 2018 and remain flat in 2019. The forecast sees unemployment rising from 4.8% in the final quarter of last year to more than 6% by the end of 2018.
Household real disposable income is forecast to fall by 0.3% in 2017, recovering by just 0.2% the following year. Consumer spending growth is set to slow to 1.7% in 2017 and 0.4% in 2018 from 2.8% in 2016.
Peter Spencer adds: “Momentum in the consumer sector does not appear to have been affected by Brexit yet. However, a weakening labour market, tepid growth in wages and rising prices on the high street will squeeze household spending in 2017, in particular on discretionary items which have been doing well over the past year.”
Exports provide silver lining
The UK’s future growth is critically dependent upon a strong trade performance, according to the EY ITEM Club forecast. A more competitive trade sector means that, net exports are expected to add 0.8% to GDP in 2018 and later years. Along with the boost to the UK’s overseas income from sterling’s weakness, a stronger trade position means that the deficit on the current account is set to narrow from 4.5% of GDP this year to 3.7% of GDP in 2018 and 2.5% in 2019.
Peter Spencer adds: “So far, exporters have taken advantage of the lower pound to increase their sterling export prices. With import prices increasing in tandem, a fall in the exchange rate tends to increase the sterling value of the visible deficit. However, the consequent surge in export profitability provides a big incentive to find overseas customers and build export capacity and expertise.”
Risks and uncertainties
Peter Spencer concludes: “The fall in the pound should help boost exports in the near term. However, trade performance and growth in 2019 and beyond will depend critically upon the exit terms that can be agreed with the EU27 and other countries. Theresa May has provided some clarity on the UK’s Brexit objectives. But with elections in the Netherlands, France and Germany due later this year, it will take longer to get the same clarity on the views of the EU27 and the shape of the ensuing negotiations.”
About EY ITEM Club
The ITEM Clubis the only non-governmental economic forecasting group to use the HM Treasury’s model of the UK economy. Its forecasts are independent of any political, economic or business bias and this independence is underpinned by the untied sponsorship of Ernst & Young LLP.
ITEM stands for Independent Treasury Economic Model. HM Treasury uses the UK Treasury model for its UK policy analysis and Industry Act forecasts for the Budget. ITEM’s use of the model enables it to explore the implications and unpublished assumptions behind Government forecasts and policy measures. Uniquely, ITEM can test whether Government claims are consistent and can assess which forecasts are credible and which are not.
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