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Uk Economic Forecast
Q2 2014
BUSINESS WITH confidence
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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.
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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.
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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)
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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.
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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
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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
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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.
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9
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