Be careful out there: building economic resilience

A challenging outlook …

These are challenging and uncertain times for the UK economy. In its recent forecast, the EY ITEM Club forecast the UK economy to grow at 1.3% in 2018 with a modest uptick to 1.4% growth in 2019, 1.7% in 2020 and 1.8% in 2021 but nothing close to a reversion to the historic trend rate of expansion of over 2%.

And these projections assume a reasonably smooth Brexit, with a withdrawal agreement and an outline of the future trading relationship by the end of March 2019 – a far from guaranteed outcome. It is important to note that not only has the outlook worsened but the risks are weighted to the downside.

The UK is not the only economy under pressure in the world today. Although the USA is growing reasonably well, global growth generally is slowing. The risk of trade disputes, heightened geo-political uncertainty, the reliance on recent years in debt fuelled growth and rising oil prices are combining to slow the global economy.

… that demands a focus on resilience …

Against this challenging backdrop, most of my presentations are met with resigned looks - it the news that no-one wants to hear. It was reassuring therefore to spend time with restructuring professionals at conferences in Birmingham and Manchester sponsored by Gateley in the last few weeks. Many of the issues I raised resonated and my calls to build resilience ahead of problems were strongly endorsed. I feel I have found some fellow pessimists!

In this environment, businesses need to ensure they are resilient enough to withstand any economic shocks. Brexit, a possible credit event in Italy, a sharp slowdown in China or an oil price hike are all possible scenarios with potentially significant consequences. First up, businesses should ensure their cash flow is robust enough to handle a period of significant disruption to make sure they will still be in business and hence in a position to deal with major structural challenges.

Beyond the potential for major shocks, there is a need to monitor the macro environment to ensure that events closer to home will not cause unexpected disruption.

… with consumers top of the list …

Consumer spending has been the main driver of growth in the UK economy over the last decade, accounting for significantly more than half of UK GDP. Consumers always come under pressure as the economy slows but the major challenges for the sector today are structural rather than driven by the economic cycle.

Consumer spending growth in recent years has been driven by the raid growth in employment while real wage growth has been disappointing. Many people are in low paid work and we have seen a significant increase in household indebtedness in the last couple of years together with a rundown in savings - consumers are struggling to make ends meet.

With employment growth likely to slow as the economy slows and migration from the EU reduces, consumer facing businesses need to make sure their plans are consistent with a lower growth environment in which online competition may well continue to drive down prices. Should inflation spike unexpectedly due to energy price increases or sterling fall if the Brexit negotiations go badly, then it could be a perfect storm of lower revenues and higher costs.

… but corporate customers not far behind …

The slowing global economy is already impacting UK trade growth with export expansion slowing in recent months. A failure to agree a Brexit transition could exacerbate this trend and so businesses involved in trade or with customers or suppliers reliant on trade should be vigilant about the impact of changes to trade performance.

With pressure on domestic customers and external ones, we can expect that business investment may come under pressure. There are signs that foreign direct investment into the UK is reducing and it is clear from official data that investment by domestic businesses is under real pressure. To ensure resilience, businesses should ensure they are investing enough to maintain their current operating capacity but also to create the scope for future growth and ask the same questions of their customers and suppliers.

… and that’s not all.

Economic risk is always with us and, even when we can identify the main threats, forecasting the impact is another challenge as segments in the economy will be affected in different ways. If interest rates increase, younger people and families are more likely to have debt and hence to be adversely impacted. However, older people with savings will be potential gainers, meaning the overall impact will vary depending on the customer profile of individual businesses.

These are challenging times and constant vigilance and regular testing of business plans and potential future impacts are essential. Even if the overall outlook remains stable, ensuring that the specifics of each individual business are also considered is key to ensuring continuing resilience.

@MarkGregoryEY