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EY ITEM Club Spring 2016 forecast: How long can the consumer drive the recovery? Peter Arnold April 2016 The last gasps of a consumer led recover, while we (still) wait for rebalancing to investment and export-led growth ► The forecast shows growth of 2.3% in GDP this year, driven largely by the consumer, the main beneficiary of the collapse in commodity prices ► However, the headwinds facing the consumer resume next year as inflation returns and taxes and other levies begin to bite ► Business investment stalled in the second half of last year and industrial surveys have weakened further this year ► Exports also stalled in the second half of 2015, while import growth picked up - the current account deficit of 7% of GDP the largest on record ► Investment should recover post-referendum Saving is at an all-time low, but the debt to income ratio is still remarkably stable… UK: Personal sector saving UK: Household debt-to-income ratio % of disposable income 14 % of disposable income 180 Savings ratio Net acquisition of financial assets 12 170 10 160 8 6 150 140 4 2 0 130 120 -2 110 -4 100 -6 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 90 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 Source : Haver Analytics Source : Haver Analytics Instead of releasing equity, people are financing housing investment by selling financial assets… UK: Financial investments and housing equity withdrawal UK: Housing equity withdrawal £bn 40 35 £bn 50 30 40 25 30 HEW 20 15 10 Housing investment 20 Cash injections 5 0 Mortgage borrowing -5 -10 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014 Source : Haver Analytics Financial investment Household Saving 10 0 -10 -20 Equity withdrawal -30 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014 Source : Haver Analytics Households have also relied on labour rather than credit markets to support spending… ► During the recession, as workers took cuts in real wages to preserve their jobs ► As the economy recovered between the end of 2009 and 2015, employment increased from 70.6% of the population of working age to 74.1% ► Average hours, which usually trend down over time, increased from 31.5 to 32.2 a week ► In contrast, the employment rate remained flat at around 72.8% between the end of 2001 and end 2007, while average hours fell from 32.5 to 31.9 a week But these trends are now likely to slow . . . . Consumption slows and the fall in unemployment comes to an end… UK: Real household income and spending UK: Unemployment % year 6 % 9 Household income Forecast Forecast 8 4 7 6 2 ILO 5 0 4 3 -2 2 -4 -6 2004 Household spending 2006 2008 Source : EY ITEM Club Claimant count 1 2010 2012 2014 2016 2018 2020 0 2004 2006 2008 Source : EY ITEM Club 2010 2012 2014 2016 2018 2020 External trade continues to disappoint … UK: Exports & world trade UK: Contributions to GDP growth % year 15 % year 4 World trade Exports (non-fuel goods) Forecast Domestic demand Net exports GDP growth Forecast 3 10 2 1 5 0 0 -1 -5 -2 -3 -10 -4 -15 -5 2004 2006 2008 Source : EY ITEM Club 2010 2012 2014 2016 2018 2020 2004 2006 2008 Source : EY ITEM Club 2010 2012 2014 2016 2018 2020 Business confidence has weakened but investment should bounce back following a vote to remain in the EU… UK: Business investment & GDP % year 20 Forecast Business investment 15 10 5 0 -5 GDP -10 -15 -20 2004 2006 2008 Source : EY ITEM Club 2010 2012 2014 2016 2018 2020 The referendum on EU membership… ► However, it will be a different story if there is a vote to leave on June 23 ► Short term, the fundamentals would remain in place during the 2 year transition period but uncertainty about the eventual settlement could hit business confidence and investment ► Scenarios for exit have been modelled by OE covering: - Trade with REU and RoW - Migration - Regulation - Fiscal and monetary policy The government response would be critical… A populist response ► A Liberal response ► Aggressive clampdown on migration ► Modest migration controls, with targeting ► No regulatory relaxation ► Maximize regulatory opportunity ► Maintain external tariff with RoW ► Abolish external tariffs ► Spend any fiscal savings ► Cut tax with any fiscal savings According to the OE report it is hard to see any net positive economic benefit under any Brexit scenario: Key: Policy direction: LIB – liberal MOD – moderate POP – populist Trade agreement: CUS – customs union BIL – bilateral accords FTA – free trade agreement MFN – most favoured nation The EY ITEM Club forecast for the UK Economy, Spring 2016 % changes on previous year except borrowing, current account and interest & exchange rates