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Uk Economic Forecast
Q1 2015
BUSINESS WITH confidence
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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.
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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.
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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.
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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.
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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
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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
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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.
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9
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