Inflation to remain low
Consumers to enjoy ‘austerity holiday’ until end of year
Consumers are expected to enjoy a prolonged “holiday” from austerity on the back of low inflation, subdued oil prices and the Chancellor’s decision to delay changes to tax credits, say economists at EY who say interest rates will not rise until at least the end of year.
The ITEM Club’s Winter Forecast is for consumer spending to increase by 2.8% in 2016, which will help push GDP growth up to 2.6%, from last year’s downward revised 2.2%.
However, as austerity bites harder and inflation picks up in 2017, they will bear down on consumer spending growth, which is forecast to slow to 2.1% in 2017 and 1.7% in 2018. This will cool the UK’s GDP growth rate to 2.3% and 2.2% respectively.
Inflation is forecast to average only 0.4% in the first quarter of 2016 and is not expected to reach the key 1% benchmark until the final quarter. According to the forecast, inflation is likely to remain below the MPC’s 2% target for a prolonged period, averaging 1.6% in 2017 and 1.8% in 2018.
The EY ITEM Club says that it will be difficult for the MPC to justify an increase in interest rates while inflation remains so low and does not expect the first rate rise until the autumn, at the earliest.
Peter Spencer, chief economic advisor to the EY ITEM Club, says: “The UK consumer had a welcome holiday from inflation and austerity in 2015, and, until recently, this had look set to come to an end.
“However, the combination of further falls in commodity prices and the money that the Chancellor found behind the sofa for his Autumn Statement ‘giveaways’, mean that this holiday will be extended into this year.
“But every holiday must come to an end. Inflation will start to pick up towards the end of 2016, while the impact of the government’s welfare savings will increasingly be felt. This will eat into spending power and cause consumer spending growth to slow.”
Mark Gregory, EY’s chief economist adds: “”The consumer led recovery will continue this year, but it’s not all good news for UK businesses who have to start preparing for life after 2016. To contend with upcoming changes like the introduction of the living wage, as well as the growing uncertainty and volatility in the world economy, businesses should be looking to adjust their plans.”
According to the EY ITEM Club, the housing market will remain buoyant in 2016. House prices are expected to increase by 6.5% this year before easing back to 4.7% in 2017. Housing investment is also forecast to increase by 6.9% this year and 8.3% in 2017.
Mr Spencer adds: “The housing market ended 2015 on a high note and we expect it to remain very active in 2016, particularly in the first quarter as landlords anticipate the stamp duty increase in April.
“The UK’s fundamental imbalance between supply and demand should ensure that house prices continue to rise. However, the buy to let market is likely to slow following the increase in stamp duty and the phasing out of mortgage interest tax relief.”
ITEM Club says UK exports should be supported by the fall in the pound against the dollar in 2016. The forecast shows exports increasing by 4% in 2016 and 4.8% in 2017.
Mr Spencer says: :”While growth in world trade remains disappointing, as a result of the slowdown in emerging markets, the UK is relatively well protected. Our traditional trading markets such as the EU and the US have performed better lately and should continue to do so. Along with a weaker pound this should see exports doing well this year.”
However, he says that risks remain for the UK economy: “We may only be two weeks into the New Year, but we have already seen evidence of the mounting global risks.
“Heightened tensions in the Middle East provide a stark reminder of the fragile geo-political situation, while China’s stock market jitters offer a reminder of how hard it will be to rebalance that economy. We expect these risks to remain in check, but as the Chancellor warned us recently, there is much which could go wrong.”