South: Economy will struggle but business-friendly Brexit is positive sign

UK growth will continue to struggle this year and next, as consumer spending feels the squeeze from rising inflation and muted earnings growth. However the economy’s medium term outlook is now looking stronger than it did three months ago, with the general election result increasing the likelihood of a more business friendly Brexit, says the latest EY ITEM Club summer forecast.

The EY ITEM Club has downgraded its UK GDP forecast for 2017 to 1.5%, down from the 1.8% it was predicting in its April report, but is more confident about growth prospects for 2019 and 2020. The report says that the general election result has increased the chances of a Brexit transition arrangement, followed by a free trade agreement, which should provide greater certainty to help stimulate business investment, as well as a looser fiscal stance. Combined with the expectation that inflation will fall back to the target by the end of next year, the EY ITEM Club is now predicting GDP growth of 1.3% in 2018 and 1.8% for 2019 – up from the 1.2% and 1.5% respectively that was previously forecast

Lacklustre growth for 2017

Peter Spencer, chief economic advisor to the EY ITEM Club, commented: “Although the general election has clouded the issue, it should result in a softer Brexit, meaning a transition arrangement, leading to a comprehensive free trade agreement further down the time-line. The outlook for this year has deteriorated since our spring forecast, but a softer Brexit should improve the medium term outlook - especially in sectors like the motor industry where investment has been held back by Brexit uncertainty.”

The EY ITEM Club expects business investment to be flat in 2017, followed by growth of 0.1% in 2018. However, assuming that the UK secures a transition agreement after Brexit and moves towards a free trade agreement, the EY ITEM Club expects business investment to strengthen to 2.1% in 2019.

Mark Gregory, EY’s chief economist, commented: “Businesses need to pull off a difficult balancing act by managing their organisation through a difficult 12 months of stuttering UK growth, while still creating the basis to grow if the medium-term outlook improves as forecast.

“Business investment has been weak in recent quarters and productivity continues to disappoint. But if businesses want to make the most of improving export markets and a more competitive pound, they will need to invest ahead of the recovery in the economy.”

Consumers are flagging says EY ITEM Club

The forecast sees the pressure on consumers worsening this year, before eventually starting to ease towards the end of 2018. With sterling’s sharp drop in the wake of the Brexit vote still to fully feed through the CPI index, CPI inflation is expected to reach 3.2-3.3% this autumn – well ahead of the growth in average earnings. The forecast sees CPI inflation averaging 2.4% in 2018, before coming back to below the 2% target by the end of next year.

Employment levels are also expected to stall, with total employment increasing by 0.9% this year, 0.1% in 2018 and 0.4% in 2019. This compares to growth of 1.7% in 2015 and 1.4% last year.

Real household disposable income is forecast to fall by 0.2% in 2017, before recovering by 1.1% next year. And with the household saving ratio at a record low of 1.7% in Q1 2017, consumers will have limited scope to mitigate the impact. As such the EY ITEM Club expects consumer spending growth to slow from a nine-year high of 2.8% in 2016 to 1.9% this year and 1.0% in 2018.  

Spencer commented: “The inflationary squeeze on consumers has been painful and shows little sign of easing any time soon. However, the pound has appreciated against the dollar while oil and other commodity prices have fallen over the last few months. With wages remaining remarkably restrained, the inflationary pressures will ease considerably next year, allowing the rise in living standards to resume. The tensions within the MPC make the outlook for base rates highly uncertain but I think they will increase in August, 2018.”

Exports will be a source of support to the UK economy

The UK’s trade balance has continued to disappoint but exports are expected to receive a boost from the weak pound and a more buoyant global economy. While this external support is unlikely to be enough to offset a weaker home market, net trade should be an important source of support to the economy. According to the EY ITEM Club report, export volumes are forecast to increase by 3.8% this year and 3.9% in 2018, while import volumes increase by 3.2% and 2.8% respectively. Net exports are expected to add 0.1% to GDP this year and another 0.3% in 2018.

Spencer added: “It goes without saying that the UK’s trade performance and output growth in 2019 and beyond will depend critically upon the exit terms that can be agreed with the EU 27 and other countries. Although the next 15 months should bring greater clarity here, it still represents a significant uncertainty, compounded by the political uncertainty following the result of the general election.”