The Q4 2018 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).
Following a pick-up in GDP growth from 0.1% in the first quarter to 0.4% in the second quarter of this year, Q3 saw momentum build further, delivering a 0.6% rise in output. Such a rise hasn’t been seen since the last three months of 2016. Each of the three main output sectors (services, industry and construction) saw output expand, and consumer spending, total investment (public and private), government consumption and net trade all made positive contributions for the first time since Q4 2017.
However, the details of Q3’s performance presented a less than favourable platform for expansion in the last quarter of 2018. The economy’s strength in Q3 was entirely accounted for by a strong performance in July, with the monthly data showing GDP flat in both August and September. This suggests that the economy carried little momentum into Q4, a prediction reinforced by a modest 0.1% rise in output in October and a weaker set of CIPS activity surveys in October and November across the services, manufacturing and construction sectors compared to results in the third quarter. Our ICAEW Business Confidence Monitor (BCM) forecast suggests growth will slip back in Q4.
Looking ahead to 2019, growth prospects look brighter. The likelihood of a steady decline in inflationary pressures will support consumers’ spending power. And our expectation that, notwithstanding recent events, a draft Brexit withdrawal agreement will ultimately be passed by Parliament should result in some pent-up business investment coming back. In addition, the fiscal loosening announced by the Chancellor in October’s Budget represents a new source of economic support. All in all, these factors point to the economy expanding by 1.6% next year. This would still be weak even by the already modest standards of the current expansion, and the still-present risk of a ‘no-deal’ Brexit would see this forecast cut significantly.
Business investment grew by 0.5% on the quarter in Q2 2018, offsetting a fall of similar magnitude in Q1. But these variations remain very modest by historical standards, and evidence from BCM suggests companies have, if anything, become more cautious over investment in recent months. After a positive reading in BCM in Q2 2018, Research & Development (R&D) budgets seem to be slowing in H2 2018, while investment in staff development is also fragile. Overall, we expect only very tentative growth in business investment in 2018 overall, at 1% (0.3pp weaker than in our previous report).
Part of the reluctance to invest is clearly down to uncertainty over the UK’s future relationship with Europe after Brexit. But as has been the case for some time, the fundamental economic and financial conditions for investment remain good. Rates of return on investment remain very strong relative to recent years, profitability is in line with historical norms, while high cash balances mean businesses have plenty of ammunition for investment. Finally, latest BCM data suggest companies’ expectations for export growth are outpacing domestic sales. In these conditions, if greater clarity were to emerge over the UK’s future trade relationship with Europe, and broader concerns about global protectionism start to ease (see Focus section), there could be upside risks to our investment forecast.
Nevertheless, with the Monetary Policy Committee’s August statement underlining future increases in interest rates would be ‘gradual’ and ‘limited’, there is minimal financial imperative for companies to accelerate capital spending just yet. Our forecast for business investment growth in 2019 overall is a modest 2.3%. Though this is the strongest rate of increase since 2015, it is only around half the average for the 2010-2015 period.
Key metrics of the UK labour market improved again in Q2 2018 but looking at the detail there may be some cause for concern. On the positive side, the unemployment rate (that is, the number of people actively seeking work as a proportion of the total seeking and in work) dropped yet further – from 4.2% in Q1 to 4% in Q2. Yet the increase in employment was just 42,000 on the quarter, much weaker than in Q1. An increase in inactivity (that is, unemployed people no longer searching for work) accounted for part of the fall in unemployment.
Part of the increase in inactivity may have been down to the introduction of Universal Credit, with some claimants mistakenly being switched from unemployment-related benefits under the old system to benefits for inactive groups under the new one. This makes it difficult to read too much into the latest figures. But the failure of wage growth to accelerate despite the historically tight labour market remains a key conundrum for policymakers – headline pay slowed in June to a nine-month low of 2.4% on a year ago.
Evidence from BCM suggests that businesses expect this pattern to persist for a while. Our latest forecast for wage growth in 2018 overall remains at 2.5%, with an increase in employment of 0.9% (again, stable compared to our last report). With companies starting to hire at a slower rate, we expect employment growth to halve in 2019 − to around 0.5% − with some modest upward pressure on wage growth, reaching 2.9% for the year.
Since the vote to leave the EU in June 2016, UK business has become increasingly engaged with trade policy debates at home and abroad. The UK’s future trade relationship with the EU is of course crucial, since 44% of the UK’s goods exports head to the continent. But agreement with countries further afield are also important – Europe’s share of British exports has been steadily declining in recent years, thanks to burgeoning trade with fast-growing economies in Asia, the Middle East and Africa (often under trade agreements negotiated between these countries and the EU, which could be lost depending on the eventual EU-UK settlement).
But given that British exporters are increasingly looking overseas for opportunity, the apparent crumbling of the global consensus in favour of free trade is worrying. Recent tensions between the US and a range of other major economies including China, Mexico, Canada, Germany and Japan have raised concerns over the prospect of a global trade war, with tariffs imposed by one side matched and raised by another, leading into a spiral of protectionism.
This matters to UK exporters even if they are not the actual targets of tariffs or other trade barriers. Lower trade between the US and China would damage both economies – and with it, their demand for goods and services from the UK. Oxford Economics’ Global Scenario Service simulates a trade war in which the US withdraws from NAFTA (the recent US-Mexico deal does not yet incorporate Canada), raises tariffs on all Chinese imports to 25%, and 10% for other major Asian emerging markets. Faced with political pressure to protect their own industries, these economies implement matching tariffs in retaliation, leading to a major slowdown in world trade and business investment, and a sharp deterioration in global financial markets.
The impact of this scenario on the UK economy would be felt keenly, even though neither the US nor its trade war adversaries were targeting imports from the UK. Via the impact of slower growth across the world economy, as well as the impact on global financial markets and investor confidence, Oxford Economics’ analysis suggests UK GDP growth would slow to almost 1.1% in 2019 (0.3pp weaker than the Oxford Economics baseline forecast). So rather than 2019 being a year when GDP growth finally picks up in the UK, it could actually mark the fifth consecutive year of slower growth than the year before.
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.