The Q3 2017 ICAEW Economic Forecast, is based on the views of those running UK plc: ICAEW Chartered Accountants working in businesses of all types, across every economic sector and in all regions of the UK, surveyed through the quarterly ICAEW Business Confidence Monitor (BCM).
Economic activity picked up modestly in Q2 2017 with GDP growth of 0.3% (0.1 percentage point stronger than Q1 2017). With slower consumer spending growth and stagnant business investment, the improvement in overall economic growth was largely due to an increased rate of stock building by firms, in addition to government spending. In spite of a weak pound, exports are also estimated to have grown by a disappointing 2.4% year-on-year. Evidence from the BCM suggests the quarterly pace of growth may have eased a little in the third quarter, dipping back to 0.2%. This is consistent with sluggish activity in the services and construction sectors at the end of Q1.
However, businesses expect a rebound in subsequent quarters, taking our forecast for annual growth to 1.6%, for both 2017 and 2018. Key to this improvement will be that companies are able to take better advantage of global trade growth, especially in light of a weaker pound. By contrast, the consumer sector will remain constrained by several drags to household spending power (see Focus section). Regulators are likely to welcome the further slowdown in consumer credit growth from July, but again this points towards a weaker outlook for consumer spending going forward.
From a policy perspective, we assume little change on either the fiscal or monetary front. The Budget in March reported the deficit in fiscal year 2016-17 would be £16.5 billion lower than expected in the 2016 Autumn Statement, with more modest savings in subsequent years. Overall, the Budget identified a £26bn headroom versus the Chancellor’s aim of bringing the structural deficit below 2% by 2020-21. Some of this was subsequently eroded by compromises to secure passage of the Finance Bill in July, and some may be needed to support safety improvements to social housing, following the Grenfell Tower tragedy. Where monetary policy is concerned, with inflation moderating and an uncertain outlook ahead, the MPC will not reach the consensus needed to start raising rates in the near term.
Business investment flatlined in Q2 2017, after a 0.6% rise in the first three months of the year. As ever, this data needs to be interpreted with caution, given both its volatility and susceptibility to revision in subsequent releases. The evidence is however strong that businesses are in no rush to undertake major investment spending at present. Our forecast, driven by indicators from the BCM survey, suggests investment will be flat in 2017 and fall by 1.1% in 2018.
The degree of political uncertainty, both in a domestic context and with respect to the UK’s relationship with the EU, is clearly a key driver of this reticence. But in several respects the fundamental economic conditions relevant for capital spending decisions remain positive. Corporate balance sheets and profitability are very healthy, borrowing costs remain low (and will do for some time), and demand in the UK’s major trading partners is strong.
In the context of stagnating productivity in the UK (with output per worker growing a tiny 0.3% in the two years to Q2 2017, compared to annual average growth of 0.8% in the previous five years), unwillingness by businesses to invest is an increasing risk to future prosperity. If the UK is to continue to compete effectively in global markets, businesses may need to take a greater leap of faith, and invest for the future despite an uncertain present. The forthcoming Budget could be an opportunity for government to strengthen the financial case for business investment, assuming uncertainty over Britain’s future relationship with the EU persists.
Please note that 2018 data in this report is forecast.
Despite the uncertainty surrounding Brexit and the result of the general election, UK firms have continued to create jobs through the first half of 2017. Q2 saw an additional 125,000 people in work, slightly above Q1 (122,000). The unemployment rate edged down from 4.6% to 4.4% - the lowest since 1975. Most positively, the proportion of working age people in employment edged up to 75.1%, the highest on record.
The latest BCM data suggests that businesses have scaled back their hiring plans, due to an increased degree of economic uncertainty. Our forecast is therefore for a 1% increase in private sector employment for 2017 (0.4 percentage points weaker than last year). Looking further ahead, BCM data implies only a very modest (0.1%) increase in employment in 2018. This pace of job creation will not be enough to absorb new entrants to the labour market, meaning the unemployment rate ticks up to 4.7% in 2018 (0.2 percentage points higher than the average for 2017). This would be the first increase in the annual average unemployment rate since 2011.
Even with this rise in the unemployment rate, the labour market will remain tight by historical standards (for example, the jobless rate averaged just over 5% in the five years leading up to the financial crisis in 2007/08). Part of the reason unemployment is likely to remain low is ongoing restraint in wage settlements as businesses are trying to control input price increases. Wages rose just 2.1% in the year to June despite inflation coming in half a percentage point higher with workers and businesses prioritising jobs over pay growth. According to the BCM this will continue, with our forecast for pay growth for 2017 overall at just 2%, picking up a little in 2018 to 2.7% (though this will still be close to stagnation in real terms).
Please note that 2018 data in this report is forecast.
Consumer spending has been a key driver of UK economic growth over the past few years, adding an average of 1.5 percentage points to GDP growth from 2014-2016. This contribution is likely to slow to 1.1 percentage points in 2017, and just 0.3 percentage points in 2018, as a range of factors combine to drag on household spending power compared to recent years, according to Oxford Economics.
Most pertinent is the acceleration in inflation over the past twelve months, from just 0.6% in the year to July 2016 to 2.9% in May 2017 (albeit seeing a modest dip since). Combined with other factors impacting household incomes, including the freeze on working age benefits introduced in April 2016, and a 1% annual rise in public sector salaries to 2019/20 (affecting 16% of the UK workforce), has left many households struggling. Household spending power (adjusted for prices), shows that household budgets are likely to fall in real terms in 2017 - the first such fall since 2011, according to Oxford Economics estimates.
Looking ahead, the impact on consumer prices from a weaker pound looks to continue for a while yet. The Bank of England’s latest Inflation Forecast projects inflation to be 2.8% in the year to Q4 2017, and remain above 2% until late 2019. There is little that the government can do about higher inflation over the next few years, other than cutting indirect taxes such as VAT (which would have a substantial fiscal cost). Given the pressures on businesses, there are no realistic measures to spur faster private sector wage growth in the near term, such as earlier hikes in the National Living Wage which would squeeze margins at a time of high input price growth.
As a result, we expect the squeeze on household incomes to continue for the next couple of years at least. In order to support profitability and growth, businesses may need to look for opportunities in overseas markets, as well as making efficiency savings, including via investment in productivity enhancing technology.
ICAEW’s forecasts for economic growth, business investment and the outlook for the labour market are based on the correlation between ICAEW Business Confidence Monitor (BCM) indicators and official economic data. The BCM contains data – from a survey of 1,000 UK businesses – on business confidence, financial performance, challenges and expectations for the year ahead to provide a unique analysis of future developments in the UK economy.