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Uk Economic Forecast Q2 2014 BUSINESS WITH confidence icaew.com/ukeconomicforecast icaew.com/ukeconomicforecast 2 Introduction Welcome to the eighth 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 3.3% to 3.4%, as business confidence remains at a record high in Q2 2014, pointing to continued resilience in the economic recovery. Growth this year is forecast to be twice the rate seen in 2013. Encouragingly, there are signs of growth broadening out beyond the services sector. Official data showed the manufacturing sector growing faster than services in Q1 2014. While construction disappointed somewhat in the first quarter, this is likely to have been weather related, and we expect the sector to bounce back significantly through the rest of the year. Indeed, the latest BCM shows construction to be the second most confident sector in terms of economic prospects (behind the property sector). The labour market has improved sharply in recent quarters and this looks set to continue. ICAEW forecasts that the unemployment rate will average just 6.4% this year, down from 7.6% in 2013. An increase in earnings growth will see employee gross incomes finally increasing in real (inflation-adjusted) terms ahead of the next election – ICAEW predicts that the average employee will see a £90 increase in their real gross annual income in 2014. While this is encouraging sign for employee living standards, we estimate that even with this growth, average salaries will still stand nearly £2,000 below 2007 levels. Before raising interest rates, the Bank of England is likely to wait until real earnings growth stands at a more meaningful level, making a rate rise in 2015 much more likely than this year. Risks remain in the economic recovery and the latest BCM highlights a couple of significant areas of concern. Firstly, with businesses expecting domestic sales to drive growth rather than exports, this clearly is not a trade-led recovery. The UK’s current account deficit – a measure of trade underperformance – stood at worryingly high levels at the end of 2013, and it could widen further this year. A continued large current account deficit is unsustainable, raising the prospect of a sterling sell-off in the future. This would lead to a sharp currency depreciation which could prove inflationary and detrimental to living standards. Secondly, skills shortages are emerging, particularly in certain sectors such as construction. If the UK is unable to provide a pool of suitably-skilled prospective employees for businesses, then these shortages could start to act as a constraint on the ability of businesses to expand and, in turn, on economic growth prospects. icaew.com icaew.com/ukeconomicforecast 3 Economic outlook Fig. 1 Real GDP – annual growth % 4 Fig. 2 Real GDP – index (2007 = 100) 3.4 3.4 3 1.7 2 1 100 0.3 0 101.9 102 1.7 1.1 104 100 99.2 98.6 98 -1 -0.8 -2 96 -3 94 -4 96.7 97.0 2011 2012 95.7 94.1 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 3.4% this year, twice as fast as the growth seen last year and up from our previous projection of 3.3%. Gross Domestic Product (GDP) in the UK grew at a quarter-on-quarter rate of 0.8% in Q1 2014, according to the Office for National Statistics’ second estimate of growth in the quarter. Growth was broad-based, with the construction, manufacturing and services sectors all expanding. Indeed, manufacturing grew faster than services in Q1, with growth of 1.4% compared with 0.9% for services. ICAEW’s latest forecasts predict that the UK economy will grow by 3.4% this year, marginally up on our previous forecast of 3.3% growth. This comes as business confidence continues to stand at record highs – the BCM Confidence Index reached +37.3 this quarter, marginally up on +37.2 in Q1 2014. If realised, this expansion will leave GDP in 2014 standing 1.9% above the pre-crisis peak seen in 2007. icaew.com/ukeconomicforecast However, this quarter’s BCM also highlights a number of possible constraints on economic expansion. Businesses expect most growth over the next year to be domestic sales rather than exports, so this is not a trade-led recovery. Rising domestic spending is likely to lead to a widening current account deficit as exports fail to keep pace with imports. The current account deficit, a key measure of the UK’s trade position compared to the rest of the world, reached an all-time high in 2013, and looks set to widen further this year. In addition, many businesses report that availability of skills is a greater challenge than a year ago – particularly concerning as the UK is still only in a fairly early stage of recovery. Inability to acquire suitably-skilled staff may act as a cap on growth, holding back economic performance. 4 Business investment Fig. 3 REAL Business investment – annual growth % 15 13.7 10 8.2 4.0 5 3.9 1.7 0 -1.0 -1.3 -5 -10 -15 -15.2 -20 2007 2008 2009 2010 2011 2012 2013 2014f Source: ONS, ICAEW forecasts Capital spending intentions continue to rise, leading to an upward revision to our business investment forecast. ICAEW has revised up its business investment forecast this quarter to 8.2% for 2014, as capital spending intentions continue to improve. This is up from a previous forecast of 7.1% growth. Business investment rose by 2.7% in Q1 2014 compared to the previous three months – the fastest quarterly growth seen in a year, putting business investment a solid 8.7% above its level in Q1 2013. Capital spending intentions have been trending up since early 2013 and, this quarter, stand at their highest level since Q3 2007. In addition, firms report growth intentions for staff development budgets at their fastest rate this quarter since Q1 2008. Investment in staff to makes a more workforce and drives business expansion. However, intentions to expand research & development (R&D) icaew.com/ukeconomicforecast budgets have fallen back in recent quarters according to the BCM. The decline in R&D intentions could hold back innovation and, in turn, productivity growth. Investment data in this quarter’s BCM point towards some rebalancing of the economy in favour of the manufacturing sector. Confidence in the Manufacturing & Engineering sector has been steadily climbing in recent quarters, with an Index reading of +35.1 in Q2 2014, up from +17.0 a year before. This latest movement is reflected in investment intentions for the sector: manufacturers expect to increase capital investment by 3.0% over the coming 12 months, up from 2.0% growth over the past 12 months. This compares favourably to the Construction and the Services sectors, which expect to hold investment growth broadly steady. 5 Labour market Fig. 4 Average earnings – annual growth % 6 5 Fig. 5 Unemployment Rate, % % 9 8.5 4.9 8 4 3 2.3 2.2 1.3 7.9 7.6 5.5 0.0 2009 6.4 6.5 6 1.3 1 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 continues to fall back sharply and we expect the rate to average 6.4% this year – sharply down from 7.6% in 2013. Further, earnings growth looks set to pick up as skills shortages place upward pressure on wages. The UK labour market continues to improve rapidly. In the three months to April 2014, the unemployment rate stood at 6.6%, 1.2 percentage points down from the same point a year before and reaching its lowest rate since late 2008. icaew.com/ukeconomicforecast This fall in unemployment was spurred on by the fastest year-onyear employment growth in 25 years, at 2.6% or 780,000 workers. The majority of this annual increase was down to full-time employment, with an increase of 678,000 workers. This move toward full-time work has helped to reduce the level of underemployment in the economy, as a lower share of people are only working part time because they couldn’t find a full time job... Overall, declining slack in the labour market is increasing the likelihood that the Bank of England will raise interest rates over 2012 2013 2014f the next 12 months, though Governor Mark Carney has emphasised that any rate rises will be gradual. ICAEW’s latest forecasts suggest that the labour market will continue to improve, with about 450,000 private sector employee jobs created over the next 12 months. Combined with rising self-employment, we expect the unemployment rate to fall to an average of 6.4% this year, down from 7.6% in 2013. In addition, skills shortages in some sectors – such as manufacturing – appear to be pushing up wage growth. Average earnings grew yearon-year in manufacturing by 2.1% in the three months to April, higher than the 0.9% overall average. Across the whole economy, we expect earnings to grow by 2.2% this year, up from our previous 2.0% forecast. 6 Focus on: real incomes – how much better off will workers be? Fig. 6 year-on-year growth in average gross employee earnings and annual CPI inflation %8 7 6 5 4 3 2 1 0 -1 -2 -3 2001 2002 Fig. 7 Average real gross employee earnings, in 2014 prices Earnings growth (three month average) CPI inflation £28,000 £27,000 £26,000 £25,000 £24,000 £23,000 £22,000 £21,000 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 £20,000 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014f Source: ONS, ICAEW forecasts The cost of living crisis in the UK is showing signs of easing, as earnings growth picks up, unemployment declines sharply and personal allowances rise. Real incomes are forecast to rise in 2014 but will remain well below the levels seen in 2007. Overall, the latest labour market data continue to provide good news for the UK and will likely cheer the Chancellor ahead of next year’s election. The opposition’s campaign on cost of living issues is likely to decline in effectiveness ahead of the election, as a growing number of households see pay rises and reductions in joblessness and underemployment. The effectiveness of a cost of living campaign will depend heavily on how myopic the electorate are. While it’s true that living standards are rising again after years of decline, they are only increasing at a snail’s pace. ICAEW’s latest earnings projections suggest that real gross employee earnings will rise by just 0.4% this year, which amounts to an annual increase of £90 in 2014 prices. Even though pay growth is picking up in 2014, we project that it will still icaew.com/ukeconomicforecast stand at about half the rate seen over the period 2000–2007. The modest increase in real employee earnings that we predict will be far from sufficient to offset years of decline. ICAEW estimates that real gross earnings this year will stand £1,989 below their 2007 peak. The opposition will likely emphasise this fact ahead of the next election, while the government and the Chancellor capitalise on the current data showing small increases in living standards. As well as the improving short-term data, the Chancellor can also point out that the headline employee earnings measures thrown around are not the best measure of living standards, and that the underlying picture is likely to be more optimistic than these data suggest. For one thing, the sharp decline in unemployment seen in recent quarters 7 Focus on: real incomes – how much better off will workers be? (continued) means that living standards are rising as people move away from out-ofwork benefits and into paid work. Secondly, many workers on average salaries have benefitted significantly from increases in income tax free personal allowances in recent years. The personal allowance has increased from £6,475 when the government came into power to £10,000 this tax year, giving many workers on average salaries an income tax cut of £705 per year. The personal allowance is set to rise further to £10,500 next April, providing many workers with a £100 boost to their disposable incomes. So the Chancellor can explain how tax changes are benefitting many households. incomes closely before moving on interest rates. As ICAEW’s latest forecasts show, although real incomes should grow this year, the pace of rises will be sluggish. A rate rise could lead to financial distress for a significant number of households; many benefitted enormously from the decline in rates during the financial crisis as mortgage interest payments fell back. Some may struggle with the shock to their spending power that could come with rising mortgage payments. Although the UK economy looks set to grow strongly this year, with the fastest pace of expansion out of all the G7 countries, the Bank of England is likely to wait until next year before raising the bank rate. By then, real earnings growth may be at a more meaningful level. The Bank of England is likely to monitor the situation on household icaew.com/ukeconomicforecast 8 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% +1.7% +3.4% +13.7% +4.0% -15.2% +1.7% -1.3% +3.9% -1.0% +8.2% 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% +2.2% Employment – annual growth +0.7% +0.7% -1.6% +0.2% +0.5% +1.2% +1.3% +2.3% 5.3% 5.7% 7.7% 7.8% 8.1% 7.9% 7.6% 6.4% 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 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 06/14