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UK Economic Forecast Q3 2014 BUSINESS WITH CONFIDENCE icaew.com/ukeconomicforecast icaew.com/ukeconomicforecast 2 Introduction Welcome to the ninth edition of the 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 across all regions of the UK, surveyed through the quarterly ICAEW/Grant Thornton UK Business Confidence Monitor (BCM). In this latest edition, we have slightly revised down our 2014 economic growth forecast from 3.4% to 3.2%, reflecting what looks like a challenging environment for exports. With the eurozone economy failing to grow in the second quarter of the year, driven by weakness among major economies such as France and Germany, the prospect of a tradeled recovery anytime soon looks slim. Having said that, economic growth of 3.2% is still solid and will be driven by a combination of consumer spending and a marked increase in business investment. The UK still looks set to be the fastest growing G7 economy this year. For the first time, we present our forecasts for 2015. The forecasts show economic growth dipping but remaining solid at 2.6%. Growth will be curbed next year by a slight slowdown in business investment in addition to declining government spending in the next parliament. The fiscal deficit remains a significant issue and although the UK’s strong recovery has driven up tax receipts, a failure to properly get to grips with government spending means that cuts will be needed in the next parliament. This will weigh on growth prospects. The latest public finances data for July show the national debt close to £100bn higher than a year ago. The UK’s labour market continues to go from strength to strength, with the unemployment rate standing at 6.4% in Q2 2014 – the lowest rate since late 2008. ICAEW expects the unemployment rate to average 6.2% for the year as a whole with a further fall to 5.5% in 2015. On the downside, average earnings growth remains weak and at least in part reflects the fact that many jobs being created in the economy are relatively low paid. ICAEW’s unemployment forecast suggests that the amount of slack in the labour market will diminish over the coming quarters. In addition, BCM data show the share of businesses operating below capacity in decline and, if recent trends persist, pre-crisis levels should be reached by early 2015 or even late 2014. With the amount of spare capacity in the economy declining, an interest rate rise from the Bank of England looks increasingly likely. On balance, ICAEW expects a rate rise to come in early 2015 rather than late 2014. Weak earnings growth and high levels of spare capacity in sectors such as manufacturing mean that the Bank is likely to wait until next year before raising rates, to ensure that recoveries in more fragile parts of the economy are not derailed. icaew.com icaew.com/ukeconomicforecast 3 Economic outlook FIG. 1 REAL GDP – ANNUAL GROWTH % 4 3.4 FIG. 2 REAL GDP – INDEX (2007 = 100) 3.2 3 1.7 2 1 106 2.6 1.7 1.1 0 100 100 99.2 94.1 95.7 96.7 97.0 98.7 2007 2008 2009 2010 2011 2012 2013 98 -0.8 -2 96 -3 94 -4 92 -5 -6 101.9 102 0.3 -1 104.5 104 -5.2 2007 2008 2009 2010 2011 2012 2013 2014f 2015f 90 2014f 2015f Source: ONS, ICAEW forecasts The UK economy is expected to grow by 3.2% this year, slightly down on our previous forecast of 3.4%. Economic growth is expected to slow but remain solid at 2.6% in 2015. Gross Domestic Product (GDP) in the UK grew at a quarter-on-quarter rate of 0.8% in Q2 2014, according to the Office for National Statistics’ (ONS’) second estimate of growth in the quarter – the same pace of expansion seen in the first quarter of the year. ICAEW’s latest forecasts predict that the UK economy will grow by 3.2% this year, slightly down on our previous forecast of 3.4% growth but still a solid economic performance which should see the UK growing faster than every other G7 economy. The downward revision to growth reflects continuing challenges in generating a sustained export-led recovery in the UK, something which has been held back by continued weaknesses in some of the country’s main export markets – most notably those in the eurozone. The single icaew.com/ukeconomicforecast currency area’s economy saw no growth in the second quarter of 2014 and, worryingly, weakness was chiefly driven by poor performance in the bloc’s three largest economies – Germany, France, and Italy. ICAEW’s first forecast for 2015 shows UK economic growth slowing to 2.6%. While still a respectable rate of expansion, additional growth will be held back by continued difficulties in generating a trade-led recovery in addition to the sizeable amount of austerity that will need to be undertaken in the next parliament. The latest public finance figures show that while the recovering economy is boosting tax receipts for the government, high levels of spending are keeping the deficit high. Significant cuts will need to be made beyond this year, and this is going to weigh on economic prospects. 4 Business investment FIG. 3 REAL BUSINESS INVESTMENT – ANNUAL GROWTH % 15 13.7 8.8 10 4.0 5 5.2 3.9 1.7 0 -1.0 -1.3 -5 -10 -15 -20 -15.2 2007 2008 2009 2010 2011 2012 2013 2014f 2015f Source: ONS, ICAEW forecasts Two years of strong business investment growth are expected, though 2014 is set to be stronger than 2015. ICAEW has revised up its real business investment growth forecast to 8.8% for 2014, with businesses reporting strong capital spending growth in Q3. This is up from a previous forecast of 8.2%. The rate of expansion in business investment is expected to slow but remain strong next year, standing at 5.2%, with ICAEW data showing that businesses expect capital spending growth to dip slightly over the next 12 months. Concerns about the eurozone, fiscal austerity in the next parliament and the prospect of interest rate rises are expected to lead to investment growth cooling from current levels. In addition, political uncertainty – on Scottish independence, future UK membership of the EU and the outcome of the general election – could be holding back some investment growth. icaew.com/ukeconomicforecast Businesses continue to sit on sizeable cash reserves, reflecting the fact that although investment is picking up, businesses on the whole remain relatively more cautious than before the financial crisis. Corporate cash reserves stood at over £500bn at the start of the year – a significant pool of funds which could be translated into investment if businesses become more confident about the prospects for growth beyond the short term. Overall, despite a slowdown, the outlook for business investment next year is strong, and businesses will increasingly need to invest to meet rising demand as the economy expands – so we may see businesses starting to tap into their cash reserves or seek capital elsewhere. 5 Labour market FIG. 4 AVERAGE EARNINGS – ANNUAL GROWTH % 6 5 FIG. 5 UNEMPLOYMENT RATE, % % 9 8.5 4.9 8 4 2.3 2.1 1.3 1.3 1.3 1 7.9 7.6 6.5 2009 2010 2011 2012 2013 2014f 2015f 6.2 6 5.5 0.0 2008 8.1 7 2.4 2 2007 7.8 7.5 3.5 3 0 7.7 5 5.7 5.5 5.3 2007 2008 2009 2010 2011 Source: ONS, ICAEW forecasts Source: ONS, ICAEW forecasts The economy continues to create a significant number of jobs, with unemployment falling sharply. This trend looks set to continue into 2015, reflecting strong hiring intentions among businesses. In the three months to June 2014, the unemployment rate stood at 6.4%, the lowest since late 2008. There were 30.6m people in work, 167,000 more than in Q1 2014 and 820,000 more than a year earlier as private sector job creation more than offset reductions in headcount in the public sector. ICAEW expects the unemployment rate to continue falling, averaging 6.2% this year and 5.5% in 2015. On the downside, ICAEW has lowered its average earnings growth forecast, from 2.2% to 1.3% for this year. This downward revision is partly due to the fact that a significant share of jobs created at present are relatively low skill – something which the Bank of England has noted in its August Inflation Report. This so-called ‘employment mix’ effect, which pushes down average earnings in the economy, is estimated to be shaving icaew.com/ukeconomicforecast 2012 2013 2014f 2015f about 0.3 percentage points off regular pay growth at the moment. Earnings growth is expected to pick up from current levels to reach 2.1% in 2015, with faster growth in the private sector partially offset by continued pay restraint in the public sector. Under the Bank of England’s policy of forward guidance, the amount of slack in the labour market is a key determinant of the future path of interest rates, with the Bank committed to keeping rates on hold until the slack in the market is significantly reduced. The latest data, which show rapidly falling unemployment, suggest that slack is diminishing. ICAEW’s latest forecasts suggest spare capacity in the labour market will decline further over the coming quarters, which could pave the way for the first change in interest rates since 2009. 6 Focus on: Spare capacity: an interest rate rise this year or next? FIG. 6 SHARE OF BUSINESSES OPERATING BELOW CAPACITY FIG. 7 BANK OF ENGLAND BANK RATE % 70 %6 60 5 50 40 30 20 4 3 2 10 1 0 0 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 2008 2008 2009 2009 2010 2010 2011 2011 2012 2012 2013 2013 2014 2014 2015 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Sources: ICAEW/Grant Thornton Business Confidence Monitor, Bank of England Declining spare capacity in the economy should pave the way for the first change in the Bank Rate since 2009. On balance, the first rate rise is more likely to take place in early 2015 than later this year. Spare capacity in the economy has become a key factor determining the future path of interest rates under the Bank of England’s policy of forward guidance, so indicators which provide a steer on the extent of this ‘slack’ – inherently hard to define and measure – have become increasingly important. The Bank estimates that slack in the economy is diminishing as the economy continues to improve, something which is also apparent in BCM data which show the share of businesses operating below capacity on a downward path. The share has declined from 62% at the end of 2012 to 50% this quarter. If spare capacity continues to decline at the rates seen in 2014 to date, then the share of businesses operating below capacity will stand at pre-recession levels by early 2015 or possibly towards the end of this year. icaew.com/ukeconomicforecast The Bank of England base rate has been on hold at 0.5% for over five years, so any increase in rates will be seen as a significant event. Speculation about the timing of the first rate rise has been rife in recent months as the UK’s economic outlook has continued to improve, and this has intensified following the release of minutes from the Monetary Policy Committee’s (MPC’s) August interest rate decision. The minutes showed the first split in the vote on interest rates since 2011, with two MPC members voting for a rate rise and seven voting to keep rates on hold. On balance and for a number of reasons, ICAEW’s forecasts suggest that a rate rise in early 2015 looks more likely than a rise this year. Firstly, the weakness of earnings growth this year means that many households may struggle with the financial 7 Focus on: Spare capacity: an interest rate rise this year or next? (continued) pressures created by even a modest increase in interest rates. Secondly, there are significant sector variations in spare capacity, and raising rates too soon could damage some more fragile parts of the economy such as manufacturing. BCM data show 69% of manufacturing firms operating below capacity this quarter, suggesting that these companies would be vulnerable to a tightening of monetary policy. Even when rates rise, increases are likely to be very gradual and subdued. The economy is recovering, but there are still significant challenges – in particular for exports and public finances. Failure to achieve a trade-led expansion could hold back the UK’s longer term growth prospects, while fiscal austerity to deal with the sizeable public sector deficit will be needed in the next parliament. Bank of England icaew.com/ukeconomicforecast governor Mark Carney has suggested the ‘new normal’ for interest rates is likely to be about 2.5% when rates start to increase, much lower than the average of 4.7% seen between 2000 and 2007. It will be important that monetary policymakers continue to nurture the UK’s economic recovery through setting appropriate interest rates. With the inflationary environment modest at present, there is little pressure to raise rates in the short term and the Bank’s Monetary Policy Committee should therefore refrain from raising rates too fast or too soon – there is no need to do so. To maintain business investment and consumer spending, it will be important that the Bank of England effectively communicates that the path of future interest rates will be gradual and limited. 8 Forecasting methodology Headline economic forecasts 2007 2008 2009 2010 2011 2012 2013 2014f 2015f Real GDP – annual growth +3.4% -0.8% -5.2% +1.7% +1.1% +0.3% +1.7% +3.2% +2.6% Real business investment – annual growth +13.7% +4.0% -15.2% +1.7% -1.3% +3.9% -1.0% +8.8% +5.2% 2007 2008 2009 2010 2011 2012 2013 2014f 2015f Earnings (total pay) – annual growth +4.9% +3.5% +0.0% +2.3% +2.4% +1.3% +1.3% +1.3% +2.1% Employment – annual growth +0.7% +0.7% -1.6% +0.2% +0.5% +1.2% +1.3% +2.8% 1.5% Unemployment rate 5.3% 5.7% 7.7% 7.8% 8.1% 7.9% 7.6% 6.2% 5.5% 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. icaew.com/ukeconomicforecast 9 About Cebr Centre for Economics and Business Research is an independent consultancy with a reputation for sound business advice based on thorough and insightful research. Since 1992, Cebr has been at the forefront of business and public interest research. They provide analysis, forecasts and strategic advice to major UK and multinational companies, financial institutions, government departments and agencies and trade bodies. For further information about Cebr please visit www.cebr.com ICAEW is a world leading professional membership organisation that promotes, develops and supports over 142,000 chartered accountants worldwide. We provide qualifications and professional development, share our knowledge, insight and technical expertise, and protect the quality and integrity of the accountancy and finance profession. As leaders in accountancy, finance and business our members have the knowledge, skills and commitment to maintain the highest professional standards and integrity. Together we contribute to the success of individuals, organisations, communities and economies around the world. Because of us, people can do business with confidence. ICAEW is a founder member of Chartered Accountants Worldwide and the Global Accounting Alliance. www.charteredaccountantsworldwide.com www.globalaccountingalliance.com ICAEW Chartered Accountants’ Hall Moorgate Place London EC2R 6EA UK T +44 (0)20 7920 8705 E [email protected] icaew.com/ukeconomicforecast linkedin.com – find ICAEW twitter.com/icaew facebook.com/icaew © ICAEW 2014 09/14