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Private activity falls; EY calls for longer stay on rates

scottish industryTwo reports published today point to a slowing in growth. Private sector activity in Scotland declined for the first time in six months during September, while consumer spending is also expected to slow down across the UK.

Both the service and manufacturing sectors registered decreases in output, says the Bank of Scotland’s purchasing managers index.

Volumes of new business fell at a marginal pace in September, while backlogs of work also declined. Despite this, workforce numbers expanded at an accelerated rate.

Donald MacRae, chief economist at Bank of Scotland, which compiles the PMI, said: “New export orders fell for the eighth month in a row. The slowdown in the Scottish economy identified in summer has taken further hold in the month of September but employment intentions suggest a return to moderate growth in coming months.”

Meanwhile, the EY Item Club autumn forecast, says the UK economy will need to boost productivity and investment to offset a slowdown in consumer spending.

It also suggests that interest rates should remain on hold until the end of next year.

Item Club says that over the last year consumers have enjoyed a “sugar rush” as falling commodity prices pushed inflation down to zero.

However, a combination of rising inflation and a tightening fiscal policy will see consumer spending growth slow from 3% in 2015 to 2.6% in 2016 and 2.1% in 2017.

The forecast predicts that the recent upturn in productivity will continue, as firms use their strong financial position to step up investment.

This, in turn, should allow wage growth to continue to steadily accelerate and help firms to weather the impact of the National Living Wage.  As a result, Item Club expects GDP growth to reach 2.5% this year before it slows to 2.4% in 2016 and 2.3% in 2017.

Inflation is forecast to start rising this winter but will remain below the MPC’s 2% target until 2018.

Peter Spencer, chief economic advisor to the Item Club says: “UK consumers should continue to make hay on the back of low inflation until the winter. But as prices start to pick up and the Budget squeeze begins to take effect in April next year, consumers will feel the effects in their pockets and spending growth will inevitably slow.

“We expect the UK economy to continue its strong performance. However future growth will depend heavily on hard-won productivity gains rather than the easy wins from energy and commodity price falls that have played an important role in supporting demand so far.”

Mark Gregory, EY’s chief economist adds: “UK productivity is set to improve, but to accelerate growth businesses will need to step up their efforts to improve their operations. After years of relying on offshoring, outsourcing and plentiful labour to reduce costs, the ability of businesses to drive real change in their activity now comes to the test.”

Item Club expects the pace of wage growth to continue to accelerate, partly as a result of the introduction of the National Living Wage. However, this should act as a spur for companies to continue to drive gains in productivity. Average earnings are expected to grow by 2.9% this year, before jumping to 3.6% in 2016 and 3.7% in 2017.

In part reflecting more expensive labour force, there is an expectation of increasing levels of investment by UK firms. Business investment is set to rise by an average of 6.1% a year from 2015 to 2020, when it is expected to reach a record high of 11.6% of GDP.

Mr Spencer adds: “In the early stages of the recovery, the strong growth in the supply of labour, partly a consequence of many of us delaying retirement, subdued wage growth. Now the UK economy is transitioning to a more normal recovery, in which real wages and productivity are both recovering.

“As part of this transition we should also see increasing levels of business investment. The recent falls in real wages encouraged firms to employ labour rather than capital to meet increases in customer demand. But, higher real wages will mean that investment is increasingly important as a way of expanding output.”

Despite an acceleration in earnings growth, the Item Club says that interest rates should remain on hold until next autumn provided that productivity also picks up. As a result, interest rates are expected to end 2016 at 0.75% and 2017 at 1.5%.

Mr Spencer says: “The MPC will be watching the labour market closely for signs of overheating. However, higher productivity growth should keep unit labour costs under wraps. Provided that happens it should stay the MPC’s hand on interest rates until next autumn.”

He concludes: “Risks to the emerging markets and the world economy have loomed ever larger over the last two years, but have been overdone. In China, despite recent economic wobbles, service industries and consumer spending, which offer some of the best opportunities for UK exporters, are still performing strongly.

“Equally, UK exports to traditional markets have seen an increase in demand, with exports to the US being particularly strong since last winter. UK businesses will have to tap into these overseas markets to counter the slowdown in domestic demand.”

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