Inflation on the rise

Weaker investment ‘will lead to slower growth’

Princes St retail shoppingGrowth is expected to slow as investment weakens over the next couple of years, according to new data.

Even so, the UK economy has shown greater resilience than many had anticipated since the EU referendum vote, says the EY Item Club.

But it expects a slowdown in consumer spending on the back of higher inflation and falling business investment.

This year the EY ITEM Club expects GDP growth of 1.9%, supported by strong consumer spending (up by 2.5%) and continued low inflation (0.8%).

However, official figures due out tomorrow are expected to show inflation has risen from 0.6% to 0.9%.

Item says inflation will accelerate to 2.6% in 2017, before easing back to 1.8% in 2018.

Consumer spending is expected to slow to 0.5% and 0.9% respectively. At the same time, uncertainty around the UK’s future relationship with the EU is likely to weigh on corporate confidence, knocking business investment back by more than 2% in 2017, after a fall of 1.5% this year.

As the UK’s trading relationship with the EU becomes clearer, growth in capital spending is forecast to slowly recover to 0.3% in 2018. As a result, the EY Item Club forecasts GDP growth of 0.8% in 2017 and 1.4% in 2018.

Its analysis points towards the UK’s exit from the EU being a relatively ‘hard’ one, with the UK post-Article 50 trading with the EU under the World Trade Organisation’s (WTO) rules.

In this scenario, offsetting the cost of losing unfettered access to the European single market will depend crucially on accessing cheaper world markets in food and manufactures. This will provide some compensation while the UK negotiates with the EU over the longer term.

UK facing period of relative low growth

Peter Spencer, chief economic advisor to the Item Club, said: “So far it might look like the economy is taking Brexit in its stride, but this picture is deceptive. Sterling’s shaky performance this month provides a timely reminder that challenges lie ahead.

“As inflation returns over the winter it will squeeze household incomes and spending. The pressure on consumers and the cautious approach to spending by businesses mean that the UK is facing a period of relatively low growth.” 

Mark Gregory, EY chief economist, adds: “The economy has not fallen off a cliff since the referendum, but recent developments have led to a more downbeat assessment of the outlook.

“The holidays are over and businesses are now looking hard at plans and budgets. Both investment and hiring plans are likely to be squeezed in the current environment.”

Export boost provides bright spot on the horizon

Supported by a weak pound, the Item Club expects exports to increase by 4.5% in 2017 and 5.6% in 2018. Net exports are forecast to add 0.8% to GDP next year, accounting for almost all of the economy’s expected growth. 

Once the UK has left the EU, the Item Club says that making use of the UK’s new-found freedoms to access cheaper international markets in food and manufactures will benefit consumers. However, competition from cheap imports are likely to impact UK manufacturers and farmers, and their exports to the EU will face tariffs and other barriers.

The slowdown in EU growth has reduced the EU’s share of UK exports from 60% in the late 1990s to around 45% currently. The EY Item Club expects growth in non-EU markets to continue to outpace the EU, lowering the EU share of UK exports further.

Nevertheless, the EY Item Club expects that a WTO-based Brexit is likely to take about 4% off UK GDP by 2030 compared to a scenario in which the UK remained in the EU.

Mr Spencer adds: “With activity in the domestic market flat, GDP growth will become heavily dependent upon exports next year. But once the UK has left the EU certain sectors, such as aerospace, automotive, and chemicals that trade extensively with the EU will be a lot more vulnerable and may need to be supported by subsidies and more robust industrial policies.

“The plus side is that the weaker pound and access to cheaper world markets will release labour and other resources and allow the economy to gradually re-balance towards non-EU exports, particularly of branded consumer goods and financial services, to emerging markets.”

Opportunities as well as challenges lie ahead

Mr Spencer concludes: “Trade performance in 2020 and beyond will depend critically upon the terms that can be agreed with the EU27 and other countries. If the UK is not going to get unfettered access to the EU market, it is vital that we get unfettered access to cheap world markets in food and manufactures.”

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