The Q3 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).
After Q1 2018 brought the weakest quarter of growth since Q2 2017, the UK economy enjoyed something of a rebound in Q2, with GDP up 0.4% on the quarter – right in line with our Q2 2018 Business Confidence Monitor (BCM) forecast. All components of domestic demand (private consumption, government spending, business investment and stock building) made positive contributions to economic expansion, while the drag from net trade looks at least partly driven by flows of non-monetary gold. Experience suggests that this could either be reversed or revised away in the months ahead.
Moving into the second half of the year, the outlook is a little more mixed though. Monthly GDP growth of 0.1% in June offers a poor launchpad for Q3. And while the CIPS surveys for service sector activity improved in August, construction and manufacturing remained weak. Our BCM forecast is for a modest deceleration to 0.3% growth on the quarter in Q3 2018.
For 2018 overall, our forecast for GDP growth remains unchanged since the last quarter at 1.3%. With three quarters of survey data, we can also make our first GDP forecast for 2019, and we expect a modest pickup in growth. Improving export performance, the continued easing of inflation (aiding consumer spending), and a very gradual increase in investment spending should help GDP growth pick up towards 1.5%. If achieved, this would be the first acceleration in annual GDP growth compared to a year ago since 2014 – but the economy grew much faster that year (3%) than seems likely for some time to come.
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.