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Uk Economic Forecast Q1 2015 BUSINESS WITH confidence icaew.com/ukeconomicforecast icaew.com/ukeconomicforecast 2 Introduction Welcome to the Q1 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 across all regions of the UK, surveyed through the quarterly ICAEW/Grant Thornton UK Business Confidence Monitor (BCM). Key findings this quarter • The economy is forecast to grow by 2.4% in 2015. This is a downward revision from our previous prediction of 2.5% growth, reflecting the impact of increased global economic uncertainty on business spending plans. • Business investment growth is expected to slow from 6.8% in 2014 to 5.2% in 2015. ICAEW’s research shows that the UK’s largest companies in particular have subdued capital spending plans for the year ahead. This probably reflects their exposure to international risks ranging from the eurozone crisis, to the Middle East conflict, to China’s cooling economy. It also reflects concerns around the policy stance towards big business after May’s general election. • The average worker will be almost £400 better off this year. Record low inflation is set to pave the way for the first annual increase in employee real incomes since the financial crisis, which should drive a significant consumer-led recovery in 2015. ICAEW’s latest forecasts show real earnings rising by 1.5% this year, leaving the average worker £380 better off. • Although the ‘cost of living crisis’ may be abating, households have a lot of lost ground to recover. ICAEW’s forecasts show that average earnings in 2015 will still be £1,810 lower than in 2007 after adjusting for price growth. • ICAEW does not expect the Bank of England to raise the Bank Rate until the end of 2015 at the very earliest, with 2016 now looking most likely for the first rise. Very low inflation means that monetary policy will remain looser for longer. The extent to which the recovery is consumer-led is an ongoing concern. With businesses cautious and exporters struggling with a gloomy economic outlook in key European markets, a trade and investment-led recovery is going to be difficult to achieve any time soon. In the short term this is not an issue, and a strong rise in consumer spending this year could be the shot in the arm that the UK economy needs to maintain momentum. But beyond 2015, the imbalanced nature of the economy could become a problem. Unless investment and exports pick up discernibly, achieving official economic growth predictions will depend on a sharp rise in household debt – and this takes the UK, worryingly, back to the same place it was in before the financial crisis. Policymakers should be looking to avoid this fate. icaew.com icaew.com/ukeconomicforecast 3 Economic outlook Fig. 1 Real GDP – annual growth Fig. 2 Real GDP – index (2007 = 100) % 4 3 108 2.6 2.6 1.9 2 1.7 1.6 1 2.4 102 0 100 -0.3 96 -3 94 -6 2007 2008 101.1 99.7 98.8 2009 99.4 97.2 95.4 92 -4.3 -5 100 98 -2 -4 103.7 104 0.7 -1 106.1 106 90 2010 2011 2012 2013 2014 2015f 88 2007 2008 2009 2010 2011 2012 2013 2014 2015f Source: ONS, ICAEW forecasts The UK economy is expected to grow by 2.4% in 2015, down from ICAEW’s previous forecast of 2.5%. Consumers will save the day in the face of considerable economic weakness in continental Europe. Gross Domestic Product (GDP) in the UK expanded at a quarter-on-quarter rate of 0.5% in Q4 2014, according to the Office for National Statistics’ (ONS) second estimate of growth in the final quarter of the year. Across 2014 as a whole GDP expanded by 2.6%, making the UK the fastest growing G7 economy. Furthermore, this growth is likely to be revised up over the coming months – official data recorded a contraction in construction output at the end of 2014. This was at odds with other indicators such as the BCM, which painted a stronger picture of the sector’s performance. ICAEW expects economic growth to slow slightly to 2.4% this year. BCM data for Q1 2015 show business confidence falling for a third consecutive quarter, with ongoing global economic uncertainty reining in investment intentions. icaew.com/ukeconomicforecast Offsetting a slowdown in investment growth will be a boost to consumer spending. Record low inflation will lead to the first annual increase in real earnings since the financial crisis, boosting household spending power and supporting domestic demand across the UK. Businesses expect domestic sales to rise by 4.9% over the next 12 months, up from the growth of 4.5% reported over the past year. The UK economic recovery remains imbalanced, with too little being driven by either investment or exports. The economy of continental Europe remains fragile, and with about half of the UK’s goods exports still going to the EU there is little scope for a trade-led recovery in 2015. Investment will also play less of a role driving growth in 2015 than it did last year. 4 Business investment Fig. 3 REAL Business investment – annual growth % 15 10 8.1 5 3.7 3.3 6.0 4.2 5.3 6.8 5.2 0 -5 -10 -15 -20 -14.4 2007 2008 2009 2010 2011 2012 2013 2014 2015f Source: ONS, ICAEW forecasts Outlook for investment revised down amid considerable uncertainty. We have revised down our forecast of business investment growth in 2015 to 5.2%, from a previous projection of 7.2%. This downward revision reflects the latest decline in business confidence and clear signs that companies intend to scale back growth in capital spending. According to BCM, firms expect investment growth to slow over the next 12 months compared with the previous year. ONS data for Q4 2014 also showed a decline in business investment at the end of last year, driven by reduced capital spending in the oil and gas extraction industries, where declining prices have reduced profitability. BCM shows that FTSE 350 companies expect to increase capital spending by just 1.4% over the next 12 months – down from the 2.1% growth seen over the past year and slower than that reported for every other type of company. These firms are likely to be especially exposed to international developments, from uncertainty in the eurozone, to terrorism in the Middle East, to the geopolitical situation in Ukraine and the slowdown in major emerging economies such as China. The unpredictability over the outcome of May’s general election in the UK is also a source of policy and regulatory uncertainty – with Labour and the Conservatives offering very different attitudes towards big business. Global economic uncertainty appears to be impacting businesses’ investment plans, something which appears to be particularly true for the UK’s largest and most international-facing firms. icaew.com/ukeconomicforecast 5 Labour market Fig. 4 Average earnings – annual growth % % 6 5 4.9 4 9 8.5 8 3.5 3 2.3 7.6 7.5 2.7 2.0 2 1.3 1.3 1 1.1 2008 2009 2010 2011 2012 2013 2014 8.1 7.6 6.2 2015f 5 5.7 5.3 2007 5.2 2008 2009 2010 2011 Source: ONS, ICAEW forecasts Source: ONS, ICAEW forecasts Unemployment continues to fall back alongside many other measures of slack in the labour market. The UK labour market is continuing to improve. For the three months to December 2014, the unemployment rate stood at 5.7%, sharply down from 7.2% over the same period 12 months ago. ICAEW expects the unemployment rate to fall further over the coming months, averaging 5.2% this year, in line with that seen just before the financial crisis. Other indicators suggest that the amount of spare capacity in the labour market is diminishing. The share of workers employed part time because they could not find a full-time job stood at 16.1% over the three months to December, down from 17.9% a year earlier. Over the latest quarter of data, part-time employment has risen by 29,000 while full-time employment has increased by a more substantial 74,000. icaew.com/ukeconomicforecast 8.0 7 5.5 -0.2 2007 7.9 6.5 6 0 -1 Fig. 5 Unemployment Rate 2012 2013 2014 2015f Falling unemployment is starting to lead to skills shortages and staff turnover issues in many parts of the economy – most notably in the construction sector according to BCM. Here, over two fifths (44%) of businesses this quarter report availability of non-management skills to be a greater challenge than a year ago, sharply up from 21% in Q1 2014. Skills shortages could start to become a significant constraint on economic growth. ICAEW expects earnings growth to accelerate from 1.1% last year to 2.0% in 2015. While still modest – between 2001 and 2007 earnings rose on average over 4% per year – very low inflation means that employees will see an appreciable increase in their living standards in 2015. 6 Focus on: the consumer-led recovery Fig. 6 Average real employee earnings – annual % chance %5 Fig. 7 UK household liabilities as a share of income, by type of liability % 200 4 3 Unsecured liabilities Secured liabilities FORECAST 150 2 1 100 0 -1 50 -2 -3 2001 2003 2005 2007 2009 2011 Source: ONS, ICAEW forecast for real earnings The falling price of essentials will boost living standards this year. But real earnings remain much lower than before the financial crisis and policymakers need to avoid a resurgence of household debt. 2013 2015f 0 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Source: OBR forecasts for household liabilities to income ratio ICAEW forecasts suggest that real (inflation-adjusted) employee gross earnings, a measure of living standards, are going to rise by 1.5% in 2015. This is the first year of growth since the financial crisis, which will leave the average employee £380 better off than last year. The increase in living standards reflects both rising earnings growth and tumbling inflation. Annual growth of the consumer price index (CPI) stood at just 0.3% in January – the lowest ever rate of inflation on this measure. Disinflationary pressures look set to continue in the first half of 2015. Retailers are still in a phase of intense competition and all of the ‘big six’ energy companies in the UK have announced a reduction in gas prices. Indeed, it’s hard to see any major part of the economy that will experience significant inflation in 2015. With icaew.com/ukeconomicforecast prices for a number of essentials lower now than a year ago, the prospect of inflation on the CPI measure dipping into negative territory – ie, deflation – is now very real. Conventional wisdom is that deflation is a bad thing which leads to a negative economic spiral as households stop making purchases in anticipation of future price falls. This is a real concern in the eurozone, which has already entered deflation, leading the European Central Bank to announce in January a €1.1 trillion quantitative easing programme in an effort to push up price growth. In the UK, deflation would be much more benign. If it occurs, it is likely to be short-lived. Further, the main driver of tumbling inflation has been falling essentials prices, where the risk of a negative spiral is small; 7 Focus on: the consumer-led recovery (continued) households won’t stop buying food because prices might be lower in a month’s time. With this kind of ‘good deflation’ lower essential costs free up household spending power and boost demand for more discretionary goods and services – which should support economic growth this year. Beyond 2015, heavily consumerdriven growth could become an issue, especially if this is accompanied by a resurgence of household debt. Following the financial crisis, annual growth in total unsecured lending to individuals was in negative territory for virtually every month from mid-2009 to late 2012 as households deleveraged. Since then credit has been rising again. This upward trend is likely to continue in 2015, complementing the boost to consumer spending from rising real earnings. For now there is no major reason to fear that the economy is on course for an unsustainable level of lending growth. However, the Office for Budget Responsibility’s (OBR) growth forecasts and, in turn, the Chancellor’s icaew.com/ukeconomicforecast ambitions for deficit reduction, are worryingly based on a strong rise in household debt levels. The latest OBR forecasts show household liabilities as a share of income rising from 159% in 2009 to 182% by 2019, with most of this increase due to growth in unsecured lending. Both in cash terms and as a share of income this would be a record level of household debt, despite years of rhetoric about moving the UK away from debt-driven economic growth. If this fate is to be avoided, policymakers may need to accept that economic growth beyond this year is going to turn out weaker than official forecasts suggest. This would mean deeper government spending cuts to eliminate the public sector deficit in the next parliament, as slower growth implies lower tax revenues. Meeting medium-term growth projections without fuelling debt requires a rebalancing of the economy away from consumer spending and towards investment and exports. This will be challenging if the global economic environment remains as volatile as it is now. 8 Forecasting methodology Headline economic forecasts 2007 2008 2009 2010 2011 2012 2013 2014 2015f Real GDP – annual growth % +2.6 -0.3 -4.3 +1.9 +1.6 +0.7 +1.7 +2.6 +2.4 Real business investment – annual growth % +8.1 +3.3 -14.4 +3.7 +6.0 +4.2 +5.3 +6.8 +5.2 2007 2008 2009 2010 2011 2012 2013 2014 2015f Earnings (total pay) – annual growth % +4.9 +3.5 -0.2 +2.3 +2.7 +1.3 +1.3 +1.1 +2.0 Employment – annual growth % +0.8 +0.9 -1.6 +0.2 +0.5 +1.1 +1.2 +2.3 +1.3 Unemployment rate % +5.3 +5.7 +7.6 +7.9 +8.1 +8.0 +7.6 +6.2 +5.2 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 144,000 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 2015 MKTPLN13825 02/15