Decent GDP growth in Q1 likely to be a ‘false dawn’ as Brexit fog continues to hang over UK


29-04-2019

The EY ITEM Club Spring Forecast has cut its GDP growth projections to 1.3% for 2019 (from 1.5% in the EY ITEM Club Winter Forecast) and 1.5% for 2020 (down from 1.7%).

Despite likely solid-looking GDP growth in the first quarter of 2019, the downward revision for 2019 primarily reflects the prolonged Brexit uncertainty, following the decision to delay the UK’s exit from the EU to a flexible 31 October deadline. A weaker global economic environment has also impacted the UK’s growth outlook.

The strong start to the year is expected to overstate the economy’s underlying strength, says the EY ITEM Club. Projected GDP growth of at least 0.4% quarter-on-quarter (q/q) in Q1 2019 was almost certainly boosted by stockpiling in the manufacturing sector, and to a lesser extent by consumers, amid concerns that a disruptive “no-deal” Brexit could have occurred in late-March. Consumers may have also brought forward some purchases in Q1 in case a disruptive Brexit occurred in late-March causing sterling to fall sharply, pushing up prices. With Brexit being delayed, some unwinding of this stockpiling threatens to weigh down on economic activity in the near term, along with other challenging factors.

The EY ITEM Club expects growth to be limited to 0.2% q/q in both Q2 and Q3 2019. In particular, business investment is likely to remain under serious pressure, having almost certainly contracted in Q1 2019 for a fifth successive quarter (the weakest performance since the 2008/9 downturn).

Howard Archer, chief economic advisor to the EY ITEM Club comments: “Delays to Brexit, a difficult domestic economic and political backdrop and slower global economic activity have resulted in a weaker outlook for UK GDP growth this year. Prolonged uncertainty is likely to impact on businesses’ willingness to invest and commit to any new major projects. There is also likely to be a hit to economic activity from some unwinding of the stockpiling that occurred in Q1.”

Will consumer spending continue to carry the economy?

After an unexpectedly resilient performance last year, which seemingly extended into Q1 2019, the EY ITEM Club forecasts consumer spending growth to slow in the near term. Consumer spending is expected to grow by 1.4% in 2019 and 1.7% in 2020. According to the Forecast, consumer price inflation is expected to average at 1.9% in 2019 before rising to 2.0% in 2020. Meanwhile earnings growth is projected to be 3.2% in both 2019 and 2020.

Howard Archer comments: “A notable feature of the economy in 2018 and Q1 2019 was how resilient consumer spending was compared to other sectors. This was underpinned by robust employment growth and improving real earnings growth, particularly since mid-2018. A key question for UK growth prospects is whether this can continue.

“We suspect that jobs and earnings growth may increasingly struggle as companies tailor their behaviour to a lacklustre domestic economy, prolonged Brexit uncertainties and a challenging global environment. While earnings growth was stable at a decade high of 3.5% in the three months to February, it was perhaps significant that it dipped to a five-month low of 3.2% in February itself. Many employers will be keen to limit their labour costs, which will also impact employment growth, and there are signs in recent surveys that the growth in pay awards has already levelled off. Consumers may therefore be cautious about making major purchases and the recent strong retail sales growth might falter.”

However, the EY ITEM Club says that consumer spending is also one of the upside risks to the Forecast. If the labour market remains robust and earnings growth firms further there could be a better than expected performance for the economy this year.

“No deal” Brexit could lead to stagnation

On the assumption that the UK leaves the EU with a “deal” on 31 October, the EY ITEM Club expects economic activity to gradually pick up. With Brexit uncertainties diluted, the EY ITEM Club expects businesses to commit to investment that has been delayed, especially if there is a perceived need to update or replace existing plant and machinery or invest in new processes. Capital spending is also likely to benefit from some companies looking to increasingly invest in automation to make up for labour shortages and to try to boost productivity. However, the upside for investment is likely to be limited by ongoing uncertainties over the economy’s longer-term relationship with the EU.

Should the UK leave the EU with a “deal” significantly earlier than 31 October, GDP growth could be slightly higher in 2019, according to the EY ITEM Club. This would be primarily due to an earlier easing of uncertainties for businesses, in particular, and consumers.

Under a “no deal” Brexit, scenario, the EY ITEM Club believes uncertainty would negatively impact business sentiment and investment, as well as consumers. Trade could be affected as non-tariff barriers kicked in, meanwhile, there could be disruption at ports, which would affect supply chains. The EY ITEM Club says that a sharp drop in the pound would be likely in the event of a ‘no-deal’ Brexit. This would help UK exporters but it would also push up businesses’ costs and consumer price inflation, thereby weighing down on households’ purchasing power. The EY ITEM Club forecasts that GDP growth would likely come in at 0.1% in 2020 after expansion of 1.2% in 2019 — with the economy likely suffering stagnation or even mild recession over the first half of 2020.

Interest rates likely to remain on hold throughout 2019

Reflecting the weaker growth outlook and prolonged Brexit uncertainties, the EY ITEM Club expects the Bank of England to keep interest rates on hold at 0.75% throughout 2019. However, it does not rule out one 25 basis point hike to 1.00% over the summer if the UK economy shows resilience and the labour market continues to strengthen. Assuming there is no interest rate hike in 2019, the EY ITEM Club expects the Bank of England to raise interest rates twice in 2020 as it looks to gradually normalise monetary policy.

Howard Archer adds: “Under normal circumstances, GDP growth of at least 0.4% q/q in Q1, a tight labour market with still robust employment growth, and firmer earnings growth would perhaps prompt an interest rate hike on 2 May after the Monetary Policy Committee (MPC) meeting. However, these are far from normal circumstances, and the Bank of England is likely to keep interest rates on hold until the Brexit situation becomes clearer and it can see how the economy is reacting. Indeed, the MPC may well see the extension of Brexit as prolonging the uncertainties facing the UK economy and increasing downside risks. While Q1 growth was likely stronger than the MPC expected, the committee will probably put this down to special factors. The currently weakened global economy and uncertain outlook could well reinforce MPC caution on raising interest rates.”

House prices could stagnate in 2019

The housing market has been largely subdued in recent months, although there are varying performances across regions with the overall national picture dragged down by the poor performance in London and parts of the South East, says the EY ITEM Club. Consequently, the EY ITEM Club expects house prices to rise by 1% over 2019 and then 2.5% over 2020 on the assumption that the UK exits the EU with a “deal” on 31 October. If the UK ultimately leaves the EU at the end of October without a “deal”, the EY ITEM Club forecasts that house prices could fall 5% over 2020.

Businesses need to be vigilant and flexible

Nick Gomer, EY’s Managing Partner in the East comments: “The outlook for the UK economy remains incredibly difficult to forecast. Brexit is one factor but the different and contradictory behaviour of individual components such as consumers and businesses means market signals are very hard to understand and there is a real risk of misinterpretation. Businesses in the East therefore need to be ready to respond as conditions change, which means investing time and resources into tracking the market, with a particular focus on the regular updates on employment numbers, pay, and inflation. These often provide the best warning signs of how businesses and consumers are faring.”

 

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