UK economy stuck in low gear

A new landscape…

The core theme of the Summer EY ITEM Club forecast was change as the general election result had cast doubt on the prevailing direction of travel of UK economic policy. Possible changes to the approach to Brexit were obviously in focus but there were also clear signs that the debate over austerity and fiscal policy had changed.

Over the summer and into autumn, the Bank of England has hardened its stance on future interest rate rises. And in its Autumn forecast, EY ITEM Club now expect a rise in November 2017, albeit they still envisage a very slow pace of tightening with future rises being well spread out.

…but little change in the overall outlook…

Yet despite several changes, in many respects things are as they were. While a formal Brexit is still 18 months away according to the official timetable, the consequences of the result of the referendum continue to influence UK economic performance. In particular, the lower value of sterling and the decline in business confidence, both of which can, at least in part, be attributed to the referendum result, continue to impact the economy. Consumer spending is slowing as real incomes come under pressure from imported inflation and consumers worry about the future, while uncertainty appears to be affecting business investment with no real signs of significant growth in capital investment. We are also seeing M&A impacted with the value of foreign investment into the UK and UK outbound activity at significantly lower values than in recent years at the 9 month mark.

With exports only adding a small amount of momentum and little change in the Government’s fiscal stance, the overall effect is for growth to remain below trend and in line with the situation at the time of the summer forecast. The UK economy appears to be growing at around 0.3 to 0.4% a quarter according to the EY ITEM Club.

…or with Brexit…

As the EY ITEM Club note, the details of the basis for Brexit remain unclear although the UK Government has stated its desire for a transition agreement, during which the UK’s relationship with the EU would continue much as it does at present. The latest forecast assumes a transition arrangement will happen and that the details of this will be clear by October 2018, creating more certainty and encouraging an increase in business investment in the later years of the forecast.

This is a best case scenario in my view. As it stands, the transition is likely to buy more negotiating time for the UK but it is not clear when the details of the future state beyond transition will be known. As such businesses will still be facing an uncertain outlook and this does appear likely to dampen risk taking.

…but little change overall…

The message to businesses remains similar to that after the summer forecast – the UK economy is stuck in a low gear with low growth compared to historic averages. The consumer sector remains under the most pressure with inflation, low cash wage rises, welfare cuts and a slow housing market all acting as drags on spending. Consumer and retail businesses are dealing with the challenges of major disruption from online in their sectors and it may be time for businesses exposed to consumer spending to undertake an in-depth review of the fit of their business models for the emerging environment.

The other key issues that all businesses should be assessing are:

• Changes to the UK labour market as Brexit comes ever closer. Although there has been anecdotal evidence of labour shortages the wage and employment data have yet to reflect this. Nevertheless constant monitoring is essential to avoid being caught out.
• It does appear that there is going to be a rise in interest rates. Businesses need to be sure their financing is in place and that they are able to cope with the new rate rise scenario;
• Political uncertainty. The landscape has changed and the Conservative Party conference featured a number of announcements signalling a more interventionist role in energy prices and housing. If there is a continued slowdown it is likely that more areas may come under scrutiny and hence businesses should continue to monitor how their operations might come into the spotlight and what the risks of this would be.

The economy has not fallen off a cliff, as some forecasts of the impact of Brexit predicted, but growth is slow and the risks are weighted towards the downside with Brexit and the labour market the most significant areas of uncertainty. Confidence is fragile and bad news or adverse developments could create a momentum of their own. It would be sensible for businesses to consider the impact of a downside case in their planning to reflect a potential sharp slowdown after Brexit while the economy comes to term with the changes.

Read the EY ITEM Club Autumn Forecast

@MarkGregoryEY

EY ITEM Club is part of our Economics for Business programme which provides knowledge, analysis and insight to help businesses understand the economic environments in which they operate.