Is the consumer growth engine running out of steam?

The end is in sight…surely?

For some time now, I have been expecting a slowdown in consumer spending growth: headwinds have been strengthening, inflation has been ticking up and changes in the external environment should have dented consumer confidence. However, as the latest EY ITEM Club Special report on consumer spending shows, consumers have continued to push ahead, spending grew by 3.1% in 2016, the highest rate for 12 years. Nominal spending (before inflation) grew at over 4%, so retailers and consumers goods companies were operating in a strong market in 2016.

UK consumer spending growth

Despite this strong 2016, the end of the consumer push is in sight. The EY ITEM Club expect that rising inflation will depress households’ spending power, particularly when set alongside the continued weakness of pay growth, less scope for further gains in employment, and welfare cuts. While there may be some support from the strength of household balance sheets, strong growth in dividend income and the prospect of tax cuts, these will not offset the negative influences. There will be a consumer slowdown and this looks set to be disproportionately borne by the less well-off.

As the pressure on real incomes grows… 

The key drivers of the EY ITEM Club consumer spending forecast are:

• CPI inflation of 2.8% in 2017;
• Modest acceleration in earnings growth from 2.4% in 2016 to 2.9% in 2017, not enough to offset the rise in inflation
• Employment virtually stagnating in 2017 and the unemployment rate ticking up to almost 5.5% by the beginning of 2018;
• Challenging conditions for non-wage income as 11.5 million UK households will continue to be affected by the cash freeze on many working-age benefits while PPI payments will continue to dwindle.

Overall, real household disposable income is forecast to drop by 0.3% this year, the first decline since 2013, with a rise of just 0.2% expected in 2018. As inflation starts to fall back, spending power will recover. However, forecast average real income growth of just 0.8% a year from 2018-20 would be less than half of the pace achieved in 2014-16.

…with differential impacts…

In terms of the outlook for different household groups, pressure on incomes and spending is set to be firmly regressive in the near-future. Alongside real-terms cuts in working-age benefits, those at the lower end of the income distribution will also suffer relatively more from increases in the price of essentials like fuel and food. But gains from future income tax cuts will go primarily to better-off households, as will those from further increases in the National Living Wage. And the continuation of the pensions “triple-lock” means that pensioners will continue to gain relative to working-age households.

Source: EY ITEM Club

…creating a “perfect storm” for businesses…

Slowing consumer spending would create challenges for businesses at any time, but it comes at a particularly difficult moment. Rising inflation will not just impact real income growth, but it also increases the costs of doing business as inputs and resources become more expensive. With other margin impacting policies such as the Apprenticeship Levy and pensions auto-enrolment to deal with in an environment of uncertainty, businesses need a clear strategy.

…that requires a clear response.

Businesses should, as a matter of urgency:

• Review their pricing, and consider what share of increased costs they can pass on. Drill down to understand the potential impact on the changes in the market at a segment level. It may make sense to allocate more resource to selling to higher-end consumers and pensioners for example, equally introducing competitive offers at the lower end of the income scale could drive market share growth if the business is the first-mover.
• Assess the potential impact of changes in the economy on the workforce. Firstly, consider labour supply and how this may change as welfare reform could potentially impact incentives to work for some groups, while the treatment of immigration in the run up to Brexit could cause a disruption in the supply of non-UK labour. These potential changes in the availability of labour could create increased demand for some skill sets in the changing labour market with implications for wage levels. Understanding future labour market dynamics is critical.
• Analyse the scope to drive productivity improvements. This might be through investing in labour saving technology, but could also be achieved by changes to supply chains. If imports are more expensive due to the change in the value of sterling, now is the time to start sourcing more inputs locally. This might provide further insurance against the failure of the UK to agree a post-Brexit trade deal with the EU.

Overall, an integrated strategic response is required linking price to costs and capital and identifying the value maximising way forward.

@MarkGregoryEY

markgregoryeconomics.ey.com

Our Economics for Business programme provides knowledge, analysis and insight to help businesses understand the economic environments in which they operate.