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UK Economic Forecast
Q4 2015
BUSINESS WITH CONFIDENCE
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2
Introduction
Welcome to the Q4 2015 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 to 2.4% this year and 2.1% in 2016. We have
revised down our forecasts for 2015 and 2016 amid a challenging environment for
exports and declining business confidence.
• Business investment growth is expected to decline from 5.5% in 2015 to 4.9% next
year. With the exception of the energy, water and mining industry, which saw a sharp
decline in capital spending this year, all major sectors of the economy expect investment
growth to slow or remain unchanged over the next 12 months.
• The labour market has picked up after a brief period of rising unemployment.
ICAEW expects the unemployment rate to decline further and average at just 4.5% in
2016, as the economy continues to expand, albeit at a slower pace than last year.
• Skills shortages are translating into high rates of pay growth in sectors such as
construction – here, total earnings in Q3 2015 were 6% higher than a year ago, double
the rate of earnings growth across the economy as a whole (which we expect to stand at
2.6% this year and 2.7% in 2016).
• The Bank of England is likely to err on the side of caution and keep interest rates
on hold until the middle of next year – a subdued environment for inflation gives the
Bank room to wait and see how the global economy develops after a tumultuous 2015.
The best word to describe the UK economy at present is ‘mixed’. Look beneath the
headline growth figures and there are wide variations in economic performance across
industry sectors, across regions and across segments of society. The economy remains
overwhelmingly services-led, with the production sector of the economy struggling as a
weak global outlook curbs export demand. BCM shows confidence for this sector dipping
into negative territory in Q4 2015.
A lopsided growth profile leaves the UK vulnerable if the sectors and regions driving the
economy start to stumble. Uncertainty over the UK’s future membership of the EU and
a possible ‘Brexit’ could undermine the country’s role as a global financial and business
services centre and as a gateway to Europe. The consumer-led recovery could also easily
unravel if there is a premature interest rate rise from the Bank of England, or a surprise sharp
increase in inflation. Overall, the UK is continuing to perform well compared with many
other major advanced economies, but it undoubtedly has some significant vulnerabilities.
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Economic outlook
FIG. 1 REAL GDP – ANNUAL GROWTH
FIG. 2 REAL GDP – INDEX (2007 = 100)
%4
110
3
2.9
2.6
2
1.5
2.2
2.0
2.4
2.1
1.2
1
108
106
102
-0.5
100
-2
98
-3
96
-4
94
-5
-6
-4.2
2007 2008 2009
105.1
104
0
-1
109.8
107.5
102.1
100
99.5
98.7
99.9
96.8
95.4
92
2010
2011
2012
2013
2014 2015f 2016f
90
2007 2008 2009 2010
2011
2012
2013
2014 2015f 2016f
Source: ONS, ICAEW forecasts
UK GDP is expected to grow by
2.4% in 2015. Our forecast for
economic growth in 2016 has
been revised down from 2.6% to
2.1% as ICAEW leading indicators
point to a slowdown.
The UK economy slowed in the third
quarter of 2015, with quarterly GDP
growth standing at 0.5%, down from
the 0.7% in Q2 2015, according to
data from the Office for National
Statistics (ONS).
Furthermore, the latest data show a
worrying divide in economic activity
at the sector level. Services continue
to account for most of the growth
seen in the economy – here, output
expanded by 0.7% in Q3 2015. In
contrast, economic output actually
declined by 0.4% in manufacturing
and 2.2% in construction.
While there is clearly an economic
recovery taking place, as evidenced
by continued GDP growth, declining
unemployment and rising earnings,
it’s clear that not all are benefiting.
Some sectors are in decline, huge
regional disparities remain and while
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UK consumers are continuing to
spend more money, net trade is acting
as a drag on growth as exports are
failing to keep pace with imports.
The outlook for the UK economy
has undoubtedly worsened in recent
months, and ICAEW has revised down
its 2016 growth forecast from 2.6%
to 2.1%, primarily reflecting the
negative impact of the deterioration
in the global outlook on both
business investment and exports.
This quarter, the BCM Confidence
Index fell to +15.6. This is down
from +22.4 in Q3 2015 and is the
lowest level of business confidence
since the start of 2013. A range of
financial performance indicators have
weakened, with businesses reporting
lower rates of growth for domestic
sales, exports and capital spending in
the final quarter of the year.
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
4.6
5.5
4.9
2015f
2016f
-5
-10
-15
-20
2007
2010
2011
2012
2013
2014
Source: ONS, ICAEW forecasts
Investment intentions
weaken as businesses
become less confident.
We have revised down our forecasts
of business investment growth in
2015 and 2016 to 5.5% and 4.9%
respectively – down from previous
forecasts of 7.4% and 5.9%. This is a
reflection of the impact of declining
business confidence on investment,
with companies reining in spending
plans amid uncertainty in the UK and
further afield.
It has been argued that the National
Living Wage, due to be introduced
next year, will encourage businesses
to invest to make their staff more
productive, helping to preserve profit
margins in the face of higher wage
bills. However, this is not reflected in
BCM this quarter. Expected capital
spending growth over the next
12 months is lower than at the start
of the year. BCM also shows that
businesses expect a slower rate of
growth in staff development budgets
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in 2016 than in 2015, casting doubt
on the notion that the National Living
Wage will lead to higher levels of
investment in staff.
With the exception of the energy,
water and mining industry, which
saw a decline in capital spending this
year following sharp falls in global
commodity prices, all major sectors
of the economy expect investment
growth to slow or remain unchanged
over the next 12 months, which
could have a negative impact on
productivity. Expected growth rates
are very mixed across industries, with
BCM suggesting that the property and
transport and storage sectors will see
the fastest rates of investment growth.
In contrast, capital spending will rise
only very modestly for manufacturing
and engineering, while the energy,
water and mining sector will see no
growth at all in investment.
5
Labour market
FIG. 4 AVERAGE EARNINGS – ANNUAL GROWTH
%6
5
4
% 8.5
8.0
4.9
7.9
8.1
8.0
7.6
7.0
2.3
2
2.7
2.6
1.3
1
-1
7.6
7.5
3.5
3
0
FIG. 5 UNEMPLOYMENT RATE
2.7
6.5
6.2
6.0
1.3
1.1
5.5
5.7
5.3
5.0
-0.2
2007 2008 2009 2010 2011 2012 2013 2014 2015f 2016f
4.5
4.5
4.0
2007 2008 2009 2010 2011 2012 2013 2014 2015f 2016f
Source: ONS, ICAEW forecasts
Source: ONS, ICAEW forecasts
After a summer blip, the UK
labour market has posted
more strong data, with the
employment rate standing
at a record high.
After ticking up slightly in Q2 2015,
the unemployment rate declined
again in Q3 to stand at just 5.3%. This
is down from 5.6% in Q2 and is the
lowest rate of unemployment since
the first half of 2008. The employment
rate for those aged 16–64 stood at
73.7%, the highest since comparable
records began in 1971.
ICAEW expects the unemployment
rate to decline further and average
just 4.5% in 2016, as the economy
continues to expand, albeit at a slower
pace than last year. This is lower than
our previous forecast of 4.7%.
The decline in unemployment will
ensure that wages continue to grow
at a solid rate over the coming year.
We expect average earnings to rise
by 2.7% in 2016, marginally up
from a 2015 estimate of 2.6% and
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5.4
comfortably above inflation which
is likely to remain below 2% on the
consumer price index (CPI) measure
until 2017 or late 2016. The National
Living Wage will also support wage
growth over the coming years, though
at the expense of slower rates of job
creation as the cost of hiring staff rises.
Skills shortages appear to be leading
to quite drastic rates of wage growth
in several parts of the economy.
According to BCM, skills shortages are
particularly acute in the construction
sector. Data from the ONS show that,
for the three months to September,
total average earnings in the sector
were 6% higher than a year ago,
double the rate of pay growth seen
across the economy as a whole.
6
Focus on: monetary and fiscal policy in 2016
FIG. 6 BANK OF ENGLAND BANK RATE, %
FIG. 7 PUBLIC SECTOR NET BORROWING, £BN
7
180
6
160
OBR July 2015
140
OBR November 2015
5
120
4
100
3
60
80
40
2
20
1
0
0
Dec
2005
Dec
2006
Dec
2007
Dec
2008
Dec
2009
Dec
2010
Dec
2011
Dec
2012
Dec
2013
Dec
2014
Dec
2015
-20
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
Source: Bank of England, Office for Budget Responsibility
Despite global concerns,
an interest rate rise might
not occur until halfway
through 2016.
As we approach 2016, there is a
growing focus on when monetary
policy will start to be normalised
across the developed world. The US
Federal Reserve looks set to tighten
policy very shortly, off the back of
strong job creation data. On the
other hand, the European Central
Bank (ECB) may actually loosen policy
further to support the eurozone’s
ailing economy. The ECB has given
strong indications that an expansion
of its quantitative easing programme
is on the cards for 2016.
The UK sits between these two
economies. It is more exposed to the
current global economic turmoil than
the US, which has a greater degree
of self-sufficiency, yet its economy is
performing considerably better than
the eurozone. On balance, a Bank of
England rate rise around the middle
of 2016 looks fairly likely at present.
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Bank Governor Mark Carney has
suggested that rates will remain
unchanged ‘for some time’.
Minutes from the Bank of England
Monetary Policy Committee’s
November meeting revealed just one
of the committee’s nine members –
Ian McCafferty – voted for a rate rise.
It could be a while before others are
on board with him. Global commodity
prices are expected to remain subdued
amid weak demand and rising supply
in areas such as oil, meaning inflation
should be contained over the medium
term even with low rates.
An interest rate rise would lead to an
appreciation of sterling, making UK
exporters, who are already struggling,
less cost competitive. An early rate
rise could also lead to a dramatic
downturn in parts of the property
market that are arguably overvalued
7
Focus on: monetary and fiscal policy in 2016
– such as London. If property market
bubbles need to be contained, this
should be done in a managed way,
preferably using macroprudential tools
(such as mortgage restrictions) rather
than interest rate rises. Overall, the
balance of arguments continues to
lean in favour of keeping rates on hold
for now.
2016 should also be an interesting
year for fiscal policy. In November’s
Autumn Statement, the Chancellor
revealed public borrowing projections
that were broadly unchanged from
July, despite a U-turn on proposed tax
credit cuts and a significant increase
in spending on housing. This reflects
in part a more optimistic assessment
of economic growth by the Office for
Budget Responsibility (OBR) compared
with July. The Chancellor also imposed
a new tax on buy-to-let investors,
with a higher rate of stamp duty for
properties purchased. This comes on
top of July’s Budget move to reduce
tax reliefs associated with buy-to-let.
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(continued)
Many believe that the OBR economic
growth forecasts are too optimistic
beyond this year. ICAEW, for example,
believes the economy will expand by
2.1% in 2016, compared with the
OBR forecast of 2.4%. The OBR seems
particularly optimistic on the outlook
for business investment growth next
year, anticipating an acceleration
in contrast to our forecast of a
deceleration. ICAEW business survey
data show little appetite to ramp up
capital spending at the moment.
The Chancellor made sure that the
borrowing figures in the Autumn
Statement continued to show the
deficit being eliminated by the end
of this parliament. But this depends
on solid economic growth. If the
economy slows after this year, the
Chancellor will be forced to adjust
his borrowing targets, cut spending
further or raise taxes – or some
combination of the three. What he
chooses is up to him.
8
Forecasting methodology
Headline economic forecasts
2007
2008
2009
2010
2011
2012
2013
2014
2015f
2016f
Real GDP – annual growth %
+2.6
-0.5
-4.2
+1.5
+2.0
+1.2
+2.2
+2.9
+2.4
+2.1
Real business investment – annual growth %
+9.7
-0.7
-16.2
+6.0
+4.9
+5.1
+2.3
+4.6
+5.5
+4.9
2007
2008
2009
2010
2011
2012
2013
2014
2015f
2016f
Earnings (total pay) – annual growth %
+4.9
+3.5
-0.2
+2.3
+2.7
+1.3
+1.3
+1.1
+2.6
+2.7
Employment – annual growth %
+0.8
+0.9
-1.6
+0.2
+0.5
+1.1
+1.2
+2.3
+1.3
+1.4
Unemployment rate %
+5.3
+5.7
+7.6
+7.9
+8.1
+8.0
+7.6
+6.2
+5.4
+4.5
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.
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9
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