UK economy to enter prolonged period of weaker growth - EY ITEM Club

The UK economy has shown greater resilience than many had anticipated since the EU referendum vote, but a slowdown in consumer spending on the back of higher inflation and falling business investment will result in much slower growth rates over the next couple of years, according to the EY ITEM Club autumn forecast.

This year the EY ITEM Club expects GDP growth of 1.9 per cent, supported by strong consumer spending (up by 2.5 per cent) and very low inflation (0.8 per cent).

However, with inflation forecast to accelerate to 2.6 per cent in 2017, before easing back to 1.8 per cent in 2018, consumer spending is expected to slow to 0.5 per cent and 0.9 per cent respectively. At the same time, uncertainty around the UK’s future relationship with the EU is likely to weigh on corporate confidence, knocking business investment back by more than 2 per cent in 2017, after a fall of 1.5 per cent this year. As the UK’s trading relationship with the EU becomes clearer, growth in capital spending is forecast to slowly recover to 0.3 per cent in 2018. As a result, the EY ITEM Club forecasts GDP growth of 0.8 per cent in 2017 and 1.4 per cent in 2018.

The EY ITEM Club analysis points towards the UK’s exit from the EU being a relatively ‘hard’ one, with the UK post-Article 50 trading with the EU under the World Trade Organisation’s (WTO) rules. In this scenario, offsetting the cost of losing unfettered access to the European single market will depend crucially on accessing cheaper world markets in food and manufactures. This will provide some compensation while the UK negotiates with the EU over the longer term.

Peter Spencer, chief economic advisor to the EY ITEM Club, said: “So far it might look like the economy is taking Brexit in its stride, but this picture is deceptive. Sterling’s shaky performance this month provides a timely reminder that challenges lie ahead. As inflation returns over the winter it will squeeze household incomes and spending. The pressure on consumers and the cautious approach to spending by businesses mean that the UK is facing a period of relatively low growth.”

Mark Gregory, EY Chief Economist, adds: “The economy has not fallen off a cliff since the referendum, but recent developments have led to a more downbeat assessment of the outlook. The holidays are over and businesses are now looking hard at plans and budgets. Both investment and hiring plans are likely to be squeezed in the current environment.”

Supported by a weak pound, the EY ITEM Club expects exports to increase by 4.5 per cent in 2017 and 5.6 per cent in 2018. Net exports are forecast to add 0.8% to GDP next year, accounting for almost all of the economy’s expected growth.

Once the UK has left the EU, the EY ITEM Club says that making use of the UK’s new-found freedoms to access cheaper international markets in food and manufactures will benefit consumers. However, competition from cheap imports are likely to impact UK manufacturers and farmers, and their exports to the EU will face tariffs and other barriers.

The slowdown in EU growth has reduced the EU’s share of UK exports from 60 per cent in the late 1990s to around 45 per cent currently. The EY ITEM Club expects growth in non-EU markets to continue to outpace the EU, lowering the EU share of UK exports further. Nevertheless, the EY ITEM Club expects that a WTO-based Brexit is likely to take about 4 per cent off UK GDP by 2030 compared to a scenario in which the UK remained in the EU.

Mr Spencer said: “With activity in the domestic market flat, GDP growth will become heavily dependent upon exports next year. But once the UK has left the EU certain sectors, such as aerospace, automotive, and chemicals that trade extensively with the EU will be a lot more vulnerable and may need to be supported by subsidies and more robust industrial policies.

“The plus side is that the weaker pound and access to cheaper world markets will release labour and other resources and allow the economy to gradually re-balance towards non-EU exports, particularly of branded consumer goods and financial services, to emerging markets.”

Mr Spencer added: “Trade performance in 2020 and beyond will depend critically upon the terms that can be agreed with the EU27 and other countries. If the UK is not going to get unfettered access to the EU market, it is vital that we get unfettered access to cheap world markets in food and manufactures.”