The Q4 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).
The economy picked up a little momentum in Q3, with growth of 0.4% (0.1 percentage point higher than each of the previous two quarters). Within this, the broad pattern of growth tilting from services toward manufacturing continued. Retail sales expanded at a rate which is slower by more than half a percentage point than the quarterly average through 2016. Manufacturing output, though, spurred by the weaker pound, rose by 1%, the best performance since Q4 of last year (see focus section).
Looking into Q4, monthly data suggested that the services sector gathered some momentum in October – although interpreting October’s retail sales data is complicated by an unusually strong October 2016. Meanwhile, although retail sales volumes in October fell versus a year earlier (the first such occasion for over four years), this largely reflects the 2% month-on-month jump in October 2016, rather than especially weak monthly data in October 2017 itself. Nevertheless, with inflation edging up to 3% in September and October, consumer spending growth will remain constrained. We forecast GDP growth of 1.5% for 2017 overall.
The squeeze on household finances will persist into 2018, with the Bank of England’s recent base rate increasing debt servicing costs for some households. With business investment remaining constrained (see next section) but support predicted to come from better trade performance, we forecast GDP growth at 1.6% in 2018. Major changes in macro policy seem unlikely in the coming couple of years however. The Autumn Statement contained little in the way of major fiscal measures outside of those aimed at the household sector, with the focus mainly on reducing the deficit against a backdrop of weaker OBR growth forecasts. Meanwhile, the MPC’s statement following November’s rate hike did not suggest that they will be tightening again anytime soon.
Official data on business investment is notoriously volatile, and prone to revision in future statistical releases. The pattern of the last three quarters does suggest however, businesses are slowing the pace of capital expenditure. After growing 0.8% in Q1 2017, business investment grew by 0.5% in Q2 2017, and just 0.2% in Q3 2017. We forecast business investment growth of 2.1% for 2017 as a whole – the second weakest year since the global financial crisis.
Looking ahead, BCM data suggests little likelihood of a rebound in business investment growth. Our forecast is for growth of just 1.5% in 2018, as companies continue to “wait and see” what kind of post-Brexit settlement the UK will achieve. It is therefore questionable whether the unexpected jump in productivity growth in Q3 2017 (output per hour grew by 0.9%, the fastest rate since 2011) can be sustained.
With corporate cash balances still very high and interest rates near all-time lows, businesses are clearly able to invest given the right economic and political outlook. So, if the government were to deliver greater clarity over future trading opportunities, businesses could well be convinced to accelerate their spending. Meanwhile, the publication of the Industrial Strategy and the measures announced in the Autumn Budget to support 5G roll-out and other technology improvements, R&D and infrastructure have the potential to yield productivity gains in the medium-to-long term, and trigger corresponding expenditures by business to exploit these new opportunities in due course.
Job creation has slowed through recent months, but this must be viewed in the context of a historically-tight labour market. Following the increase in headcount of 125,000 in Q2 2017, total employment fell by 14,000 in the three months to September. Nevertheless, unemployment fell by 59,000, leaving the unemployment rate at 4.3%, which is the lowest rate since 1975. Labour force participation (the proportion of working-age people in or seeking employment) dipped from 78.7% to 78.4% (still the third-highest reading on record), but the roll-out of Universal Credit may have played a role in this and should not be a cause for concern unless it continues.
Evidence from BCM suggests businesses continue to hire at a modest rate, albeit increasingly running into constraints on the availability of skilled labour – especially in sectors where overseas workers make up a large part of the workforce. When combined with ongoing contraction in public sector employment, our forecast is for total employment growth in 2018 of just 0.5% - half the pace of 2016-2017, and a third of the pace seen in 2015. However, with growth in the working-age population also slowing, the unemployment rate should remain stable around current rates in 2018.
Consequently, the labour market will remain tight, despite slowing job creation. Our forecast is for wage growth to remain steady, at just over 2% in nominal terms. This will feel closer to a real wage increase than in recent quarters, given that inflation should cool in the months ahead. The Bank of England’s November Inflation Report noted that “inflation is expected to fall back over the next year … to approach the 2% target by the end of the forecast period”.
Please note that 2018 data in this report is forecast.
One of the most visible impacts of the result of the Brexit referendum was the depreciation of the pound – sterling lost 6% versus the euro overnight, and 8% versus the US dollar. Exchange rates have fluctuated over the intervening period, but overall the pound is now 10% weaker versus the dollar, and 14% weaker against the euro.
The weakened sterling sparked hopes of a rebalancing of the UK economy from services and consumption towards manufacturing and exports. Yet in the first few quarters post-referendum, domestic demand looked increasingly vulnerable, without a corresponding improvement in the tradable sector. Part of this was probably the time-lags in renegotiating prices with overseas customers and in higher overseas profits feeding into domestic spending. Businesses were also faced with higher input costs – Producer Price Inflation (PPI) spiked above 10% in late 2016. PPI has been easing since the summer however, and BCM evidence shows manufacturing companies expect a further cooling in cost growth in the coming 12 months.
More recent data suggests a weaker pound is at last starting to yield more substantial gains for exporting businesses. The three months prior to September 2017 saw exports of goods (excluding erratic items) growing at the fastest rate since 2011. This reflects a particularly buoyant manufacturing sector, where survey measures of activity such as the PMI suggest output has seen a sustained run of growth. Companies evidently expect this good run to continue − in the BCM, manufacturers have anticipated annual growth in headcount in the next year at around 1.5% in each of the last three quarters, 1pp faster than the same metric in the Q3 2016-Q1 2017 data.
The improved contribution of the trading sector to the economy is also being aided by the services sector. According to Visit Britain, the number of overseas visitors to the UK in the first seven months of 2017 was up 8% on the same period a year before.
Looking ahead, although there are obvious risks to the UK’s trade prospects from Brexit, and the potential for “no deal”, the exporting and manufacturing sectors do at least now seem to be benefitting from a weaker pound – as well as the strength of demand in some key trading partners and the broad-based acceleration in world trade. BCM data suggests manufacturing businesses expect a good year for exports in 2018, though still slightly weaker than 2015 with anticipated growth in the coming 12 months of close to 5%, but export expectations remain weaker in services.
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.