EY ITEM Club downgrades UK growth prediction

The UK economy continues to display a lack of momentum and shows little sign of breaking the pattern of uninspiring growth seen in 2017, according to the latest forecast from the EY ITEM Club.

The EY ITEM Club’s Spring Forecast expects UK GDP to grow by 1.6 per cent in 2018, a modest downgrade from 1.7 per cent in the EY ITEM Club’s Winter Forecast, and then by 1.7 per cent in 2019.

The severe weather seen at the end of February and the first half of March appears to have weighed down significantly on economic activity at the beginning of the year. The EY ITEM Club said it expects that GDP growth in the first quarter of 2018 was dragged down to around 0.2-0.3% quarter-on-quarter (q/q) but forecasts it to bounce back to 0.5 per cent q/q in the second quarter as some of the activity lost to the severe weather is made up.

Howard Archer, chief economic advisor to the EY ITEM Club said: “The UK economy is chugging along at a fairly steady but uninspiring rate. On the surface, the outlook appears stable. Inflation, which impacted consumer spending last year, continues to drop and we expect a tight jobs market to deliver some uptick in pay growth. Significantly, a transitional Brexit agreement between the UK and EU has been agreed which should also bring some certainty to businesses and support investment, although it still needs to be ratified. However, these factors may be offset by rising interest rates, a recovery in sterling’s value and still appreciable Brexit uncertainties bringing new headwinds over the year.”

EY said consumers can expect to see a ‘double positive’ for real income growth, with inflation set to fall and stronger pay growth anticipated. The EY ITEM Club forecasts real household income growth to hit 1.1 per cent in 2018 and 1.4 per cent in 2019, a substantial improvement on 2017’s 0.2 per cent rise.

However, with the household saving ratio expected to stabilise after hitting a record low (5.1 per cent) in 2017, and the strength of the jobs market reducing scope for further employment gains, the EY ITEM Club says that stronger income growth is unlikely to result in an improvement on 2017’s 1.7 per cent rise in consumer spending. The EY ITEM Club forecasts consumer spending growth to weaken to 1.2 per cent in 2018 before rebounding to 1.6 per cent in 2019 as inflation is limited to around 2 per cent over the year, earnings growth picks up modestly further, the freeze on working-age benefits ends, and household balance sheets strengthen.

According to the report, the combination of a tight labour market and firming earnings growth are likely to fuel the hawkish instincts of the Monetary Policy Committee (MPC) and result in two interest rate rises in 2018. The EY ITEM Club is also now forecasting two additional rate hikes in 2019 as the Bank of England looks to gradually but steadily normalise monetary policy.

Howard Archer, chief economic advisor to the EY ITEM Club said: “Raising interest rates this year is not an open and shut case for the MPC. With inflation heading down and the Bank of England’s view of the supply-side of the economy arguably too pessimistic, two rate hikes this year risk exerting unnecessary pressure on consumers.

“However, the impact on growth from higher interest rates should be limited by the proportion of households with a mortgage, which currently lie at their lowest levels. There has also been a shift from variable-rate to fixed-rate mortgages in recent years. In addition, the burden of interest payments to the average household was at a record low at the end of 2017, and so consumers are in a relatively healthy position to cope with dearer money.”

A buoyant global economy helped bolster the UK economy last year in the face of domestic difficulties, and the contribution made by net trade to GDP growth was among the strongest over the last 25 years, according to the EY ITEM Club.

The report expects global growth to pick up further, with the UK’s major export markets forecast to expand at a decent pace.

However, a recovery in sterling, particularly against the US dollar, means that the ‘sweet spot’ in exchange rates enjoyed by UK exporters is set to be soured. In addition, the recent increase in protectionist rhetoric, originating in the US, also poses some potential downside risks to the outlook for global growth. There are also currently signs that growth in the Eurozone may be slowing more than expected in 2018 after a buoyant 2017.

The EY ITEM Club forecasts that UK export growth will fall to 3.3 per cent in 2018 from 5.7 per cent in 2017, before reaching 3.4 per cent in 2019.

Business investment should be supported by greater clarity over Brexit after a transition period was agreed in March. However, with a weak end to 2017 providing a poor launch pad for growth this year, the EY ITEM Club expects business investment to expand by 1.7 per cent in 2018 before picking up to 2.7 per cent in 2019.

Mark Gregory, EY’s chief economist said: “Technology, shifts in consumer behaviours, and demographics are all reshaping the economic landscape. If businesses fail to adapt and invest now, they could find the future becomes even more challenging.

“Businesses should not take the stable, if sluggish, economic forecast as an excuse to sit and wait. It’s important to test their short-term resilience and mitigate the potential risks while thinking hard about the future.”