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Uk Economic Forecast Q1 2014 BUSINESS WITH confidence icaew.com/ukeconomicforecast icaew.com/ukeconomicforecast 2 Introduction Welcome to the seventh 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 revised up our 2014 economic growth forecast from 2.9% to 3.3%, as business confidence hit a new record high in this quarter’s BCM. Confidence has now been increasing for six consecutive quarters – a sustained and significant period of rising business prospects. Overall, the UK economy should see some rebalancing of growth this year, with business investment making a relatively strong contribution to economic expansion and helping reduce the focus of growth on consumer spending. ICAEW expects real business investment to grow by 7.1% this year, the fastest pace of expansion since 2007. Trade remains a significant concern in the current recovery, however, with this quarter’s BCM suggesting that the UK’s already poor trade position could worsen further this year. Despite the rise in business confidence this quarter, export growth has failed to pick up in the latest BCM. With import growth likely to accelerate amid rising consumer spending and business investment, the trade deficit could widen as the UK imports more than it exports. This will bear down on the pace of expansion in the short term. The labour market is expected to continue its rapid improvement in 2014, with the unemployment rate averaging 6.6%, down from 7.6% last year. Earnings growth is expected to increase from 1.3% in 2013 to 2.0% this year, though this is still very weak compared with typical pre-financial crisis levels. Having said that, recent declines in inflation mean that this year should see earnings at least keeping pace with price growth, easing some financial pressures on UK households. The rapid fall in unemployment, much faster than anticipated by the Bank of England, has led to a rewrite of the Bank’s policy of forward guidance on the future path of interest rates. As of February, the Bank will now look at a broad range of labour market indicators to measure the amount of slack in the economy. The extent of this slack – which the Bank estimates amounts to 1.0–1.5% of GDP – will be used to inform the future path of interest rates. Broader labour market indicators point to significant slack in the economy even though unemployment has fallen, with a near-record high share of part-time workers working part time because they cannot find suitable full-time work. BCM measures of spare capacity also show that many businesses – particularly in the Production and Construction sectors – are operating below capacity, suggesting that an immediate Bank Rate rise remains unwarranted. icaew.com icaew.com/ukeconomicforecast 3 Economic outlook Fig. 1 Real GDP – annual growth % 4 Fig. 2 Real GDP – index (2007 = 100) 3.4 3.3 3 1.7 2 1 100 0.3 0 102.0 102 1.8 1.1 104 100 99.2 98.7 98 -1 -0.8 -3 2012 94.1 94 -4 2011 95.7 96 -2 96.7 97.0 92 -5 -5.2 -6 2007 2008 2009 90 2010 2011 2012 2013 2014f 2007 2008 2009 2010 2013 2014f Source: ONS, ICAEW forecasts The UK economy is expected to grow by 3.3% this year – the fastest pace of expansion since 2007 and up from our Q4 2013 forecast of 2.9% growth. Gross Domestic Product (GDP) in the UK grew at a quarter-on-quarter rate of 0.7% in Q4 2013, according to the Office for National Statistics’ second estimate of growth in the quarter. For the year as a whole, the economy expanded by 1.8% – the fastest pace since the financial crisis. ICAEW expects economic growth to accelerate further this year, with GDP rising by 3.3% in 2014. This is up from our previous forecast of 2.9% and broadly in line with the Bank of England’s central forecast presented in its February Inflation Report. This upward revision to our growth forecasts reflects a continued rise in business confidence. The BCM Confidence Index stands at +37.2 this quarter, surpassing Q4 2013’s +31.7 to stand at a new all-time high. Confidence has increased for six consecutive quarters, suggesting that icaew.com/ukeconomicforecast the economic recovery has gained significant momentum. This year, ICAEW expects the UK economy to rebalance successfully in some respects, but not others. Investment is likely to expand relatively strongly in 2014 as businesses increase capital spending. This will support economic growth alongside consumer spending, which was by far the largest driver of growth last year. In addition, the Construction sector should see rapid expansion this year and return closer to typical pre-crisis levels of output. Businesses in this sector report record-high confidence this quarter; it stands much higher than in the Production and Services sectors. Despite the rise in business confidence this quarter, export growth has failed to pick up in the latest BCM and this 4 Economic outlook (continued) is where some concerns about the economic recovery lie. The UK has been running an annual trade deficit – importing more than exporting – since 1997, and this is weighing on growth prospects. In this quarter’s BCM, businesses expect exports to grow by 3.9% over the next 12 months, down from predicted growth of 4.4% in Q4 2013. Lacklustre export growth, combined with rising imports as consumer spending and business investment grow, mean that the trade deficit is likely to widen this year. icaew.com/ukeconomicforecast One threat to the UK’s economic prospects comes from Russia’s actions in the Crimean peninsula, which may provoke the implementation of trade sanctions affecting the price of energy and wheat exports from the region. Although the chances of such sanctions being imposed are relatively low, the impact of uncertainty created by disruption in the political environment presents a risk to growth outlook. 5 Business investment Fig. 3 REAL Business investment – annual growth % 15 13.7 10 7.1 4.0 5 3.9 1.7 0 -1.2 -1.3 -5 -10 -15 -15.2 -20 2007 2008 2009 2010 2011 2012 2013 2014f Source: ONS, ICAEW forecasts ICAEW’s business investment forecast has been revised up as companies have become more confident. ICAEW expects real business investment growth of 7.1% this year. The latest capital investment figures in BCM show growth in capital spending picked up as companies became more confident in the economic outlook. Businesses report the fastest expected capital investment growth since Q3 2007. Overall, ICAEW expects real business investment to grow relatively strongly, by 7.1%, this year. This is more optimistic than the Office for Budget Responsibility (OBR) December forecast of 5.1% growth in 2014. In recent quarters, reported investment growth among businesses has generally surpassed projections from a year earlier, pointing to an improving investment environment. While businesses have been relatively cautious in their investment plans, accelerating economic growth appears to have led many of them to ramp up investment by more than expected. Nevertheless, corporate cash reserves remain high, at about £500bn icaew.com/ukeconomicforecast according to the latest estimates, suggesting that businesses on the whole are relatively cautious about investing their cash. The government may need to do more to assure businesses about the sustainability of the current recovery, to encourage conversion of these cash reserves into investment. There is a mixed picture for capital investment at an industry sector level. Capital investment growth plans for the coming 12 months are broadly unchanged for the Production industries compared with Q1 2013, while they have increased in the Construction and Services sectors. Overall, though, ICAEW’s latest forecasts suggest that business investment should make a notable contribution to growth this year, helping to ensure that the economy is not too reliant on consumer spending to drive things forward. 6 Labour market Fig. 4 Average earnings – annual growth % % 6 5 Fig. 5 Unemployment Rate, % 9 8.5 4.9 8 4 3 2.3 1.3 1.3 2.0 1 7.9 7.6 0.0 2009 6.6 6.5 6 5.5 2008 8.1 7 2.4 2 2007 7.8 7.5 3.5 0 7.7 5.7 5.3 5 2010 2011 2012 2013 2014f 2007 2008 2009 2010 2011 Source: ONS, ICAEW forecasts Source: ONS, ICAEW forecasts The unemployment rate has fallen rapidly, causing the Bank of England to rewrite its policy of forward guidance. ICAEW expects the unemployment rate to average 6.6% this year, down from 7.6% in 2013. Although pay growth is expected to pick up in 2014, it will remain low by pre-financial crisis standards. The UK labour market has rapidly improved in recent quarters. In Q4 2013, the unemployment rate stood at 7.2%, 0.4 percentage points lower than in the previous quarter and close to the 7.0% mark at which the Bank of England’s Monetary Policy Committee (MPC) would have started to consider raising the Bank Rate under its August 2013 policy of forward guidance. An acceleration in economic growth this year means that unemployment is likely to fall further; ICAEW expects the unemployment rate to average 6.6% this year, the lowest since 2008. The rapid fall in unemployment is faster than the Bank of England anticipated so it has rewritten its August policy of forward guidance on the future path of interest rates. The Bank will now look at a broad range of labour market indicators, such as underemployment (the number of icaew.com/ukeconomicforecast 2012 2013 2014f part-time individuals who would like to work full time), to measure the amount of slack in the economy. The extent of this slack will be used to inform the future path of interest rates. Despite rapidly declining unemployment, earnings growth remains subdued according to the latest data, though this is expected to improve in 2014. ICAEW expects average employee earnings growth to increase to 2.0% this year, reflecting rising bonus payments and a pick-up in regular salary growth in line with the improving economic environment. However, this growth is less than half the average of 4.3% seen between 2001 and 2007. 7 Focus on: spare capacity – when will interest rates rise? Fig. 6 % of businesses operating below, at and above capacity Fig. 7 % of part-time workers who are working part time because they can’t find full-time work % 70 60 50 Below capacity 40 At capacity 30 20 10 0 Above capacity Q1 2008 Q1 2009 Q1 2010 Q1 2011 Q1 2012 Q1 2013 Q1 2014 % 20 18 16 14 12 10 8 6 4 2 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: ICAEW/Grant Thornton Business Confidence Monitor, ONS, OBR forecasts for household debt The Bank of England’s new forward guidance on interest rates will take account of a broad range of indicators, including the amount of slack in the UK economy. ICAEW’s indicators show that slack remains significant – particularly in the Production and Construction sectors – though there are signs of more businesses operating at capacity. In its February Inflation Report, the Bank of England provided new forward guidance on when it will consider raising interest rates. In the report, it was revealed that the Monetary Policy Committee (MPC) has decided to loosen the dependence of a Bank Rate change on the unemployment rate reaching 7.0%. Last August, the Bank announced that it would consider raising rates when unemployment fell to this level, but the faster-than-expected improvement in the labour market last year has led the Bank to revise the August guidance. Given that the unemployment threshold is likely to be reached within the next few months the MPC has now committed to looking at a broad range of labour market indicators, in addition to unemployment, to inform the future path of interest rates. In icaew.com/ukeconomicforecast particular, the MPC estimates that there is a great deal of spare capacity within the economy, amounting to 1.0%-1.5% of GDP, and that much of this is concentrated in the labour market. Based on this indicator, there is no need for an immediate tightening of monetary policy. Many labour market indicators highlight significant slack remaining in the economy. For example, on the latest data nearly one fifth (18.1%) of part-time workers are working part time because they cannot find full-time employment – a near-record high share. ICAEW’s indicators, included in the quarterly BCM report, also confirm that spare capacity remains a feature of the economy. Over half of businesses (53%) report operating below capacity this quarter, though 8 Focus on: spare capacity – when will interest rates rise? (continued) this is down from the high of 62% seen in Q4 2012. Although the share of businesses operating below capacity has been on a trend downward path in recent quarters, as the economy has strengthened, it remains relatively high. This suggests that there is no need for an immediate rise in interest rates. Spare capacity is more of an issue in some sectors than others, with businesses in the Construction and Production sectors more likely to be operating below capacity than their counterparts in the Services sector. Over three fifths of companies in the Construction and Manufacturing & Engineering sectors are operating below capacity this quarter, at 63% and 69% respectively, a figure which falls to 50% for Services firms. The variations in spare capacity have led to markedly different labour market trends in different sectors. Between icaew.com/ukeconomicforecast 2007 and 2013, the number of workforce jobs in the Manufacturing and Construction sectors fell by 14.0% and 11.3% respectively, according to ONS data, while jobs in the Services sector rose by 3.3%. The loosening of forward guidance to a broader-based indicator approach will ease the pressure on the MPC to raise the Bank Rate over the coming months, as many indicators still show significant slack in the economy. ICAEW’s data show that spare capacity remains substantial across much of the economy, though the extent of this spare capacity should decline sharply this year as economic growth accelerates – paving the way for a possible rate rise in early 2015. Even when interest rates do rise, however, the pace of these rises is likely to be very gradual, to prevent a derailment of the current recovery. 9 Forecasting methodology Headline economic forecasts 2007 2008 2009 2010 2011 2012 2013 2014f +3.4% -0.8% -5.2% +1.7% +1.1% +0.3% +1.8% +3.3% +13.7% +4.0% -15.2% +1.7% -1.3% +3.9% -1.2% +7.1% 2007 2008 2009 2010 2011 2012 2013 2014f Earnings (total pay) – annual growth +4.9% +3.5% +0.0% +2.3% +2.4% +1.3% +1.3% +2.0% Employment – annual growth +0.7% +0.7% -1.6% +0.2% +0.5% +1.2% +1.3% +1.4% 5.3% 5.7% 7.7% 7.8% 8.1% 7.9% 7.6% 6.6% Real GDP – annual growth Real business investment – annual growth Labour market forecasts Unemployment rate 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 10 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 03/14