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UK Economic Forecast
Q3 2015
BUSINESS WITH CONFIDENCE
icaew.com/ukeconomicforecast
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2
Introduction
Welcome to the Q3 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).
For the first time, this quarter we present forecasts for 2016 as well as 2015.
Key findings this quarter.
• The economy is forecast to grow by 2.6% in both 2015 and 2016. Our 2015 forecast
has been revised up from 2.3%, as a post-election bounce in business confidence points
to faster economic expansion over the coming months. In addition, rising earnings
growth and very low inflation are continuing to boost household spending power.
• Business investment is expected to grow by 7.4% this year, but a slowdown to
5.9% in 2016 is expected. Declining spare capacity should encourage some businesses
to invest, though a weakening global economic outlook will curb investment among
other companies. Capital spending in the energy, water & mining sector is expected to
fall back as commodity prices remain subdued.
• We have revised up our unemployment forecast for this year. We now expect the
unemployment rate to average 5.4% in 2015, up from a previous forecast of 5.1%. The
latest labour market data showed a slight increase in unemployment. Firms appear to be
making better use of existing staff, with full-time work on the increase while part-time
work declines. This should boost productivity in the economy.
• Deficit reduction could easily turn into a three parliament problem – the
Chancellor’s July Budget decisions saw him reduce the pace of fiscal austerity compared
with the March Budget. Slower growth beyond 2016 could easily leave the UK with a
fiscal deficit after the next general election.
Despite a turbulent few months for the global economy – with clear signs of a notable
slowdown in China and Greece’s debt crisis rumbling on – the UK has continued to fare
relatively well.
However, there are significant risks over the coming months and years. It’s becoming
increasingly clear that the world economy has lost momentum. As well as weakness in
China, international trade data have been worse than expected. For now, the UK economy
is being propped up by business investment and the boost to household spending power
from low inflation and rising earnings. But global events could soon start to impact the UK
more severely, particularly if further impetus is lost. While our central forecast is for the Bank
of England to raise interest rates in early 2016, it may decide to wait longer if the world
economy continues to slow.
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3
Economic outlook
FIG. 1 REAL GDP – ANNUAL GROWTH
FIG. 2 REAL GDP – INDEX (2007 = 100)
%4
110
3
2.8
2.6
1.9
2
1
0
-1
2.6
2.6
1.7
1.6
108
0.7
102
-0.3
100
98
96
-4
100
101.1
99.7
98.8
99.4
97.2
95.4
94
-4.3
2007 2008 2009
104.1
104
-3
-6
106.8
106
-2
-5
109.6
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
2.6% in both 2015 and 2016.
The global economy presents a
significant risk to these forecasts.
UK economic growth accelerated in
the second quarter of 2015, with GDP
expanding at a quarter-on-quarter rate
of 0.7%, up from 0.4% in Q1 2015.
Household spending, exports and
business investment all contributed to
growth in the quarter.
Overall, the economy looks set to
post a solid performance across the
year as a whole – ICAEW now expects
growth of 2.6% this year, up from a
previous forecast of 2.3%. The latest
BCM Confidence Index shows a sharp
improvement in business sentiment
following the decisive outcome of the
general election which ended months
of uncertainty.
In addition to improving business
confidence, consumers are also
generally benefiting from current
developments in the labour market.
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Earnings growth has picked up since
2014 and, at the same time, inflation
stands close to zero – something
which looks set to continue over
the coming months as oil and other
commodity prices remain subdued.
Households are seeing a significant
increase in their spending power –
something which is likely to persist
into 2016.
Beyond this year, we expect economic
growth to remain steady at 2.6% in
2016. However, there are sizeable
downside risks to these projections.
With the Chinese economy slowing
and a flurry of weak international
trade data, the world economy seems
to be losing momentum. Ultimately
this is going to hold back exports and
curb business investment in the UK.
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
2012
2013
8.0
7.4
2014
2015f
5.9
-14.4
0
-5
-10
-15
-20
2007
2008
2009
2010
2011
2016f
Source: ONS, ICAEW forecasts
Investment forecast for this
year revised up as
confidence increases and
spare capacity declines.
However, growth is
expected to slow in 2016.
With a post-election bounce in
business confidence this quarter, we
have revised up our 2015 business
investment growth forecast from
4.0% to 7.4%.
However, we expect business
investment growth to slow in 2016
to 5.9%. The slowdown in major
parts of the global economy is
expected to curb some investment,
particularly among the largest,
most export-dependent industries.
Partially offsetting this will be
diminishing slack in the UK economy.
BCM shows that there are now more
firms operating at, or above, capacity
than there are below capacity.
water & mining sector. Declining
capital spending here is unsurprising
given the outlook for commodity
prices. Global economic fragility is
bearing down on demand for oil
and metals and, in turn, prices. At
the same time, increasing world oil
supply is also curbing prices – to the
detriment of the UK’s oil industry.
Iraq’s oil production climbed to an
all-time high in July and the lifting of
international sanctions against Iran
will also boost global oil supplies and
keep prices low. Ultimately, this means
that the UK’s energy, water & mining
sector is in for a tough time.
BCM shows that all major sectors of
the economy expect to expand capital
spending over the next 12 months,
with the exception of the energy,
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5
Labour market
FIG. 4 AVERAGE EARNINGS – ANNUAL GROWTH
% 6
5
4
% 8.5
4.9
3.5
2.3
2.7
2.6
1.3
1
1.3
2.7
1.1
2007 2008 2009 2010 2011 2012 2013 2014 2015f 2016f
8.0
6.2
6
5.7
5.3
5
4.5
5.4
4.7
2007 2008 2009 2010 2011 2012 2013 2014 2015f 2016f
Source: ONS, ICAEW forecasts
Source: ONS, ICAEW forecasts
The labour market has turned
a corner. Expect slower job
creation, but a more solid rate
of earnings growth.
The labour market has reached
something of a turning point on
the latest data. After a period of
sustained and significant falls,
unemployment has ticked up. In
Q2 2015, unemployment rose by
25,000 compared with the previous
quarter, but remained 221,000
lower than a year ago. While ICAEW
expects unemployment to start
declining again later in the year, we
have revised up our unemployment
rate forecast for 2015 as a whole
from 5.1% to 5.4%. We expect the
rate to decline to 4.7% in 2016.
The latest labour market data suggest
that, rather than hiring new staff,
companies may be making better
use of their existing workforce –
something which should boost
productivity in the economy. Between
Q1 2015 and Q2 2015, the number
of full-time employees rose by 12,000,
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7.6
7
6.5
5.5
-0.2
8.1
7.6
7.5
2
-1
7.9
8
3
0
FIG. 5 UNEMPLOYMENT RATE
while the number of part-time
employees declined by 66,000. The
share of part-time workers doing so
because they could not find a full-time
job fell from 16.1% to 15.8%.
Although job creation has slowed,
earnings growth has picked up since
the start of the year. We now expect
average employee earnings to grow
by 2.6% this year, significantly higher
than the annual growth of about
1% seen over the period 2012-2014
and up from our previous forecast of
2.0%. We expect similar wage growth
in 2016.
The introduction of the National
Living Wage, announced in the July
Budget, is expected to contribute to
the continuation of higher earnings
growth in 2016. It will apply to all
workers aged 25 and over and start at
£7.20 per hour in April 2016.
6
Focus on: Austerity in the new parliament
FIG. 6 REAL GOVERNMENT CONSUMPTION –
ANNUAL % CHANGE
FIG. 7 PUBLIC SECTOR NET BORROWING, £BN
180
3
2.5
2
160
March 2015 Budget
March 2015 Budget
140
120
July 2015 Budget
July 2015 Budget
1.5
100
1
80
0.5
60
40
0
20
-0.5
0
-1
-1.5
-20
2014
2015
2016
2017
2018
2019
2020
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: OBR Economic & Fiscal Outlook, March and July 2015 publications. Note that a negative net borrowing figure means the government is running a fiscal surplus
The first Conservative Budget
in nearly 20 years saw an easing
in the pace of austerity.
In the first Conservative Government
Budget in nearly 20 years, the
Chancellor announced a raft of new
policies. Many had been mentioned
before the July Budget, such as
increases in inheritance tax thresholds
and personal allowances. But there
were some rabbits pulled out of the
hat. It was announced that corporation
tax will be reduced to just 18% by the
end of the current parliament. The
Chancellor’s announcement of a
National Living Wage, left right to the
end of his Budget speech, also caught
many by surprise.
All in all, the policies announced are
a mixed bag for businesses. Further
reductions in corporation tax will
continue the progress made in the
last parliament in making the UK
one of the most desirable advanced
economies in which to do business.
But the National Living Wage
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represents a significant cost increase
for some firms, particularly in sectors
where low pay is relatively prevalent
such as retail, hospitality and care. In
addition, other policies such as the
removal of Dividend Tax Credit and
the levy on large employers to fund
apprenticeships will also negatively
impact some businesses.
The overall economic implications
of this Budget are not immediately
obvious – especially as some probusiness policies have been at least
partly offset by policies which are
costly to businesses. Households, too,
have seen the Chancellor give with
one hand and take with another.
Many of those benefiting from the
National Living Wage, for example,
also face significant reductions in the
amount of government benefits they
will receive.
7
Focus on: Austerity in the new parliament
The fiscal implications of the Budget
are more immediately apparent.
Compared with the coalition
government’s March Budget, the
Conservative’s July Budget actually
shows a lower level of austerity over
the next five years. Government
consumption is now expected to grow
in every year of the new parliament,
even once adjusted for inflation. In
the March Budget, sizeable declines
had been announced over the
period 2016-19. The Chancellor now
does not expect to be running a
fiscal surplus, with the government
receiving more than it spends, until
2019/20 – the very last fiscal year
of the new parliament. Previously,
the Chancellor expected a surplus in
2018/19.
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(continued)
In short the Chancellor has opted
for a strategy where there is less of
a chance of austerity significantly
bearing down on economic growth.
He has now left balancing the
government’s books until right at the
very end of the parliament. If growth
in the medium term falls short of
the OBR’s predictions – something
which seems very likely if the global
economy continues to falter – deficit
reduction will easily shift from being
a two parliament problem to a three
parliament one. That could lead to
some awkward conversations at the
next general election.
8
Forecasting methodology
Headline economic forecasts
2007
2008
2009
2010
2011
2012
2013
2014
2015f
2016f
Real GDP – annual growth %
+2.6
-0.3
-4.3
+1.9
+1.6
+0.7
+1.7
+3.0
+2.6
+2.6
Real business investment – annual growth %
+8.1
+3.3
-14.4
+3.7
+6.0
+4.2
+5.3
+8.0
+7.4
+5.9
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
+1.4
+1.3
Unemployment rate %
+5.3
+5.7
+7.6
+7.9
+8.1
+8.0
+7.6
+6.2
+5.4
+4.7
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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