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UK Economic Forecast
Q1 2016
BUSINESS WITH CONFIDENCE
icaew.com/ukeconomicforecast
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2
Introduction
Welcome to the Q1 2016 ICAEW Economic Forecast, based on the views of the people
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/Grant Thornton UK Business Confidence Monitor (BCM).
Key findings this quarter
• Economic growth is expected to slow from 2.2% in 2015 to 2.0% this year. We have
revised down our forecast amid turbulence in global financial markets and declining
business confidence.
• Business investment growth is expected to cool from 6.4% in 2015 to 5.2% this
year. Though the financial position of the corporate sector is very strong, confidence
has faltered and the amount of spare capacity in firms has risen. As a result, the BCM has
reported a progressive weakening in investment intentions over the past year.
• After a hiatus in summer 2015, the labour market has reverted to the pattern of
strong job creation and falling unemployment. ICAEW expects employment growth to
slow, but the unemployment rate is forecast to fall a little further, averaging 5.0% in 2016.
• Even though the labour market has tightened, pay growth appears to have
plateaued. The introduction of the National Living Wage will offer some support, but we
expect earnings to grow by 2.8% in 2016, a similar pace to last year.
• The Bank of England is likely to keep the Bank Rate at 0.5% throughout 2016 – the
renewed fall in the oil price points to inflation remaining lower for longer, while the
Monetary Policy Committee (MPC) is reluctant to move until it has seen wage growth
strengthen. However, low interest rates are encouraging strong lending growth in some
sectors, which may necessitate targeted intervention from the Financial Policy Committee.
The performance of the UK economy in 2015 was underwhelming and unbalanced.
Though consumers made good use of the substantial boost to their spending power,
ensuring a strong performance from the services sector, external facing sectors, most
notably manufacturing, struggled in the face of soft demand in key markets and the
strength of the pound.
The economy should gain better balance this year, but at the cost of slightly slower growth.
The boost to spending power enjoyed by consumers last year will steadily fade as inflation
gradually picks up, while faltering confidence means that growth in business investment
is also likely to cool. On the other hand, exporters should face less of a struggle as they
benefit from the recent depreciation of the pound and an improved performance by the
US and European markets. Nevertheless, the risks to growth are heavily skewed to the
downside, with concerns about China and the emerging markets prominent.
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3
Economic outlook
FIG. 1 REAL GDP – ANNUAL GROWTH
FIG. 2 REAL GDP – INDEX (2007 = 100)
%4
112
2.9
3 2.6
2
1.5
2.2
2.0
1
2.2
2.0
1.2
106
105.0
102.1
102
-0.5
100.0 99.5
100
-2
98.7
98
-3
96
-4
-5
107.3
108
104
0
-1
109.4
110
-4.2
-6
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016F
95.4
99.9
96.8
94
92
90
2007 2008 2009
2010
2011
2012
2013
2014
2015 2016F
Source: ONS, ICAEW forecasts
Our forecast for GDP growth in
2016 has been revised down from
2.1% to 2.0%. The early part of
the year has seen significant
turbulence in financial markets,
but ICAEW leading indicators
point to a much more modest
loss of momentum than that
implied by markets. Growth
should become more balanced,
with the mini-consumer boom
expected to fade and export
prospects to improve.
Economic growth accelerated from
0.4% to 0.5% in the fourth quarter
of 2015, according to data from the
Office for National Statistics (ONS).
However, this completed a year
in which the performance of the
economy underwhelmed, with growth
in each quarter being below the longterm trend.
Furthermore, there has been a
significant divergence in fortunes at
the sectoral level. The services sector
has continued to benefit from the
strength of consumer spending and
accounted for all of the economic
growth in Q4. By contrast, industrial
production contracted by 0.5%,
heavily influenced by the continued
poor performance of exporters, while
construction output fell by 0.4%.
There has been significant turbulence
in financial markets since the
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beginning of the year, but while
ICAEW leading indicators have
deteriorated a little, they point
to a much more modest loss of
momentum than markets imply. In
particular, the BCM confidence index
fell from 15.6 in Q4 2015 to 11.4
in Q1 2016; while this represents a
three-year low, it is still some way
above the levels seen at the height
of the eurozone crisis. As such, we
have revised down our 2016 growth
forecast from 2.1% to 2.0%.
The BCM results also suggest that
growth should become slightly better
balanced over the coming year.
Firms expect a recovery in export
sales, no doubt supported by the
recent weakening of sterling, while
retailers’ confidence has deteriorated
appreciably, suggesting that they
expect the mini-consumer boom to
come to an end.
4
Business investment
FIG. 3 REAL BUSINESS INVESTMENT – ANNUAL GROWTH
%
15
10
9.7
6.0
5
0
-0.7
-16.2
2008
2009
4.9
5.1
2.3
4.7
6.4
5.2
-5
-10
-15
-20
2007
2010
2011
2012
2013
2014
2015
2016F
Source: ONS, ICAEW forecasts
Fragile confidence has seen
firms rein in investment
intentions, even though
their financial position
remains very strong. Both
the forthcoming
referendum on the UK’s
membership of the EU and
the recent turbulence in
financial markets, have
contributed to the
uncertain outlook and we
expect business investment
growth to slow from 6.4%
in 2015 to 5.2% this year.
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Business investment grew more than
twice as quickly as GDP in each of
the past two years and, as a result,
it has reached its largest share of the
economy for 14 years. The financial
position of firms remains robust and
is supportive of further strong growth
in business investment. The ratio of
corporate profits to GDP is well above
historical norms, while firms’ cash
holdings are near to record levels and
credit availability is much improved.
Furthermore, rates of return of
investment are at record levels in the
services sector.
However, while the financial position
of the corporate sector may be
supportive, the motivation for firms
to invest has weakened. The BCM
suggests that confidence has faltered
since the middle of 2015, coinciding
with increased concerns about the
global economy, particularly China,
while the number of firms operating
below capacity increased for a second
successive quarter. These factors have
translated into relatively soft investment
intentions. As a result, we expect
business investment growth to slow
from 6.4% last year to 5.2% in 2016.
The results of the BCM suggest that
the link between excess capacity and
soft investment intentions is
particularly acute in the Manufacturing
& Engineering sector; the survey
suggests that almost three quarters of
manufacturers are operating below
capacity and in this context it is no
surprise that the sector reported the
weakest expectations for capital
spending. This is likely to be particularly
damaging for investment in R&D.
5
Labour market
FIG. 4 AVERAGE EARNINGS – ANNUAL GROWTH
FIG. 5 UNEMPLOYMENT RATE
%5
% 9
4.3
4
2.9
2.6
2.3
2
2.8
1.7
1.3
1
8.1
8.0
7.6
6 5.4
5
6.2
5.7
5.4
5.0
4
3
0.7
2
-0.3
0
7.9
7
3.3
3
-1
7.6
8
1
2007
2008
2009
2010
2011
2012
2013
2014
2015 2016F
0
2007 2008 2009 2010 2011 2012
Source: ONS, ICAEW forecasts
Source: ONS, ICAEW forecasts
After a brief pause, the labour
market has returned to its
previous pattern of strong
job creation and falling
unemployment. We expect
unemployment to continue
to decline, albeit more slowly,
averaging 5.0% in 2016. In
spite of tighter labour market
conditions and the impending
introduction of the National
Living Wage, the BCM
suggests that wage growth
will remain relatively subdued.
The latter part of 2015 saw the
labour market revert to the pattern
of strong job creation and falling
unemployment. The three months
to December saw the employment
rate reach another new record high
of 74.1%, while the unemployment
rate remained stable at just 5.1%, the
lowest rate since late 2005. However,
wage growth remains weak, with the
Bank of England’s regional agents
reporting that the slowdown is, in
part, linked to the very low rates of
inflation seen last year.
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2013
2014
2015 2016F
Further tightening of the labour
market will ensure that wages
continue to grow at a solid rate and
the introduction of the National Living
Wage will also support wage growth,
albeit at the expense of slower rates
of job creation as the cost of hiring
staff rises. We expect average earnings
to rise by 2.8% in 2016. This will
ensure further strong real wage gains
for workers, with the consumer price
index (CPI) measure likely to average
just 0.5%.
ICAEW expects the recent pickup
in productivity growth to continue,
resulting in a gradual slowdown in
employment growth. This will also
mean that while the unemployment
rate falls further, it does so only very
modestly, averaging 5.0% in 2016.
6
Focus on: Will financial policy be tightened before monetary policy?
FIG. 6 MARKET INTEREST RATE EXPECTATIONS
FIG. 7 TIMING OF 1ST INTEREST RATE RISE*
% 2.0
% of forecasters
30
1.8
1.6
January 2016
25
1.4
1.2
February 2016
20
1.0
15
0.8
0.6
10
0.4
0.2
0
5
2014
2015
Inflation Reports:
2016
Aug15
2017
2018
Nov15
Source: Bank of England
Since the start of 2016, financial
markets have been particularly
turbulent on the back of
concerns about China and
emerging markets. Despite its
relative lack of exposure to these
areas, the UK has been caught
up in this sell-off, which has also
extended to much lower
expectations for future interest
rates. It now looks unlikely that
UK interest rates will rise before
mid-2017. But low interest rates
are encouraging strong lending
growth in some sectors, so the
Bank of England’s Financial
Policy Committee may soon be
forced to intervene.
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2019
Feb16
0
Q1 2016
Q2 2016
Q3 2016
Source: Reuters survey of economists
Global financial markets have been
particularly turbulent since the
beginning of 2016, with the Dow
Jones Global Equity index falling by
7.3% in January alone. Nervousness
about China and other emerging
markets has been the main reason for
the collapse in confidence and, even
though it has relatively little exposure
to these markets, the UK has been
caught up in the sell-off, with the
FTSE All Share index declining by 4%
in January.
The market moves have not just
been confined to equities; market
expectations for future interest rates
have dropped significantly. At the
beginning of January, market pricing
implied that the first rise in UK interest
rates would come in the autumn of
2016, but by the time of the February
Inflation Report this had moved out to
summer 2018 and markets were also
Q4 2016
Q1 2017
*Surveys taken before MPC meetings
pricing a 25% chance of a rate cut in
2016. This move came despite a lack
of any hard evidence that the outlook
for the real economy had deteriorated
materially since the start of the year.
The expectations of financial
markets and economists have been
different for some time, with markets
consistently expecting the first rate
hike to come later. To some extent
this reflects the idea that they are
forecasting slightly different things;
economists tend to produce modal
forecasts, which depict the most
likely outcomes, whereas market
expectations are more of a mean
forecast, weighted according to
the spread of risks. Given that most
commentators agree that the risks to
economic growth are heavily skewed
to the downside, it is perhaps no
surprise that market expectations are
particularly dovish.
7
Focus on: Will financial policy be tightened before monetary policy?
The February Inflation Report offered
the Monetary Policy Committee the
first opportunity to give its view of
how the outlook had changed since
the beginning of the year. While it
suggested that the outlook for both
GDP growth and inflation was a little
softer than it previously thought, due
to a combination of lower commodity
prices and the frustratingly slow
pickup in wage growth, it gave the
clear impression that it thought
that the recent market moves were
overdone and that the next move in
interest rates was more likely to be
up than down. The Bank’s forecast
suggested that wage growth was likely
to gradually accelerate over the next
couple of years, dragging inflation
back towards the 2% target by the
end of 2017. This forecast looked to
be consistent with a first rise in the
Bank Rate around the second quarter
of 2017, with gradual increases in the
region of 0.5% per year thereafter;
a little less aggressive than the
economists’ consensus, though still
well ahead of the market view.
Though the monetary policy
framework is centred on the outlook
for inflation, there are also broader
considerations for the Bank.
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(continued)
Very low interest rates have provided
breathing space for the household
sector to restructure its balance
sheets, reducing the debt-to-income
ratio from close to 170% in 2008
to around 140% now. However,
there is evidence that some sectors,
most notably unsecured household
lending and buy-to-let mortgages, are
now starting to see relatively strong
lending growth at rates approaching
those seen before the financial crisis.
Very low levels of interest rates are
undoubtedly a factor behind this
strength.
This poses something of a dilemma for
the Bank, as clearly the case for raising
interest rates is weak for the economy
as a whole, particularly given the
strength of the headwinds coming
from fiscal policy. So the case for the
Bank to use its macroprudential tools
to intervene on a more targeted basis
is becoming increasingly compelling.
It has yet to make use of these recently
acquired powers and they would
represent something of a step into the
unknown. But the ability to deal with
specific problems, rather than using
the blunt tool of higher interest rates,
looks particularly attractive in the
current climate.
8
Forecasting methodology
Headline economic forecasts
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016f
Real GDP – annual growth %
+2.6
-0.5
-4.2
+1.5
+2.0
+1.2
+2.2
+2.9
+2.2
+2.0
Real business investment – annual growth %
+9.7
-0.7
-16.2
+6.0
+4.9
+5.1
+2.3
+4.7
+6.4
+5.2
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016f
Earnings (total pay) – annual growth %
+4.3
+3.3
-0.3
+2.9
+2.3
+1.3
+0.7
+1.7
+2.6
+2.8
Employment – annual growth %
+0.8
+0.9
-1.6
+0.2
+0.5
+1.1
+1.2
+2.3
+1.5
+1.1
Unemployment rate %
+5.4
+5.7
+7.6
+7.9
+8.1
+8.0
+7.6
+6.2
+5.4
+5.0
Labour market forecasts
ICAEW’s forecasts for economic
growth, business investment and the
outlook for the labour market are
based on the correlation between
ICAEW/Grant Thornton Business
Confidence Monitor (BCM) indicators
and official economic data. BCM
contains data – from a survey of
1,000 UK businesses – on business
confidence, financial performance,
challenges and expectations. BCM
indicators provide a useful and unique
steer on future developments in the
UK economy.
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9
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