UK economy set for a ‘hard rebalancing’, says EY ITEM Club

The recent slump in sterling should prompt a significant readjustment of the UK economy away from consumer spending towards exports, according to the EY ITEM Club winter forecast.

But while economic growth will be better balanced it is also likely to be slower.

The EY ITEM Club says that the impact of sterling in increasing import costs will see inflation rise to 3.1% by the final quarter of 2017, before easing back to 2 per cent by the end of 2018.

This is expected to have a knock on impact on consumer spending, as growth in disposable incomes is eroded. However, the weak pound and a softer domestic market are likely to encourage higher levels of UK exports, as businesses seek income opportunities overseas, resulting in exports increasing by 3.3 per cent this year and 5.2 per cent in 2018.

According to the report, this rebalancing of economic activity will be accompanied by three years of relatively slow growth.

The EY ITEM Club expects GDP growth to reach 1.3 per cent in 2017 (up from the 0.8 per cent it predicted in October’s forecast, but down from an expected 2 per cent in 2016) and just 1 per cent in 2018. The MPC is predicted to hold interest rates at their current 0.25 per cent until the spring of 2018.

Peter Spencer, chief economic advisor to the EY ITEM Club, said: “We now expect the impact of Brexit on the UK economy to be shallower, but more prolonged than we did in October. However, there is a sea change coming over the next three years. The fall in the pound will force the economy to be less reliant on consumer spending, leaving growth heavily dependent upon trade performance.”

Mark Gregory, EY Chief Economist, adds: “Whatever the outcome of the Brexit negotiations, there are clear indications that the fall in the pound and the UK’s exit from the EU will entail a change in the structure of the UK economy. The onus will be on businesses to adapt to the slowing domestic economy by seeking opportunities overseas.”

The EY ITEM Club forecast says that 2017 will see a progressive slowdown in consumer spending as the engine of employment growth stalls and inflation accelerates, squeezing household incomes.

After increasing by 1.8 per cent in 2015 and 1.4 per cent last year, employment is forecast to rise by just 0.2 per cent in 2017, fall by 0.2 per cent in 2018 and remain flat in 2019.

The forecast sees unemployment rising from 4.8 per cent in the final quarter of last year to more than 6 per cent by the end of 2018.

Household real disposable income is forecast to fall by 0.3 per cent in 2017, recovering by just 0.2 per cent the following year. Consumer spending growth is set to slow to 1.7 per cent in 2017 and 0.4 per cent in 2018 from 2.8 per cent in 2016.

Peter Spencer said: “Momentum in the consumer sector does not appear to have been affected by Brexit yet. However, a weakening labour market, tepid growth in wages and rising prices on the high street will squeeze household spending in 2017, in particular on discretionary items which have been doing well over the past year.”

The UK’s future growth is critically dependent upon a strong trade performance, according to the EY ITEM Club forecast. A more competitive trade sector means that, net exports are expected to add 0.8 per cent to GDP in 2018 and later years. Along with the boost to the UK’s overseas income from sterling’s weakness, a stronger trade position means that the deficit on the current account is set to narrow from 4.5 per cent of GDP this year to 3.7 per cent of GDP in 2018 and 2.5 per cent in 2019.

Peter Spencer said: “So far, exporters have taken advantage of the lower pound to increase their sterling export prices. With import prices increasing in tandem, a fall in the exchange rate tends to increase the sterling value of the visible deficit. However, the consequent surge in export profitability provides a big incentive to find overseas customers and build export capacity and expertise.”

Peter Spencer added: “The fall in the pound should help boost exports in the near term. However, trade performance and growth in 2019 and beyond will depend critically upon the exit terms that can be agreed with the EU27 and other countries. Theresa May has provided some clarity on the UK’s Brexit objectives. But with elections in the Netherlands, France and Germany due later this year, it will take longer to get the same clarity on the views of the EU27 and the shape of the ensuing negotiations.”