A BRIGHT LIGHT AMID GATHERING DARKNESS

Transcription

1 UK ECONOMIC OUTLOOK QUARTERLY MARCH A BRIGHT LIGHT AMID GATHERING DARKNESS UK economic growth has remained solid relative to our previous forecast in November, powered by sound domestic demand. While we expect this to continue ahead, we have downgraded our forecasts for both and 217, key drivers of which are: downward revisions to historical GDP data; slower wage growth bearing down on household spending; and softer economic momentum taking the edge off of business investment. Meanwhile, risks to the outlook remain firmly skewed to the downside, with the EU referendum on the horizon and global growth softening against a background of greater financial market volatility. With UK growth momentum apparently softening and inflation likely to remain lower for longer, an interest rate rise before the end of the year looks unlikely. Data revisions reveal softer momentum over... Overall, the UK economy grew solidly over the course of and the composition of growth remained similar to that in - powered by domestic demand, with a negligible contribution from net trade. However, revisions to national accounts data show that momentum over last year was slightly softer than previously thought growth for the year came in at 2.2%, against our November forecast of 2.4%. But the drivers of these revisions were broad-based in both directions: the contribution from net trade was lower, but fixed investment was higher, and household and government spending were broadly unchanged....partly driving a downgrade to our forecast Despite softer momentum over than we previously expected, our broad view of the UK economic outlook remains unchanged: we still expect relatively resilient GDP growth ahead, supported by domestic demand. However, we have downgraded our forecasts for UK GDP growth: to 2.3% in (from 2.6% previously) and 2.1% in 217 (from 2.3%). Data revisions are a key driver of this downgrade in, accounting for around two-thirds of the change to our forecast in that year. However the boost from household spending growth is also slightly smaller, reflecting both slower wage growth in recent months (see In focus) and in our forecast the latter in turn partly reflects a slower recovery in productivity. We also expect a larger drag from net trade, as the resilience in domestic demand fuels strong import growth, offsetting a pick-up in exports. In 217, slower GDP growth weighs on business investment growth, while lower real household incomes bear down on housing investment. Risks remain skewed to the downside Downside risks to the UK s otherwise solid economic outlook have intensified since our last forecast. Perhaps the most immediate risk is that uncertainty ahead of the EU referendum delays plans for investment and expansion, tempering growth through the middle of the year. However, there is little sign of this happening so far, with investment intentions in both our surveys and others holding up well. The UK also remains exposed to a number of global headwinds. Global growth momentum has weakened further since our last forecast, as China s economy continues to slow and the outlook for emerging markets has deteriorated. While the UK s direct links with the emerging world are relatively small, a further worsening in that region could dent global growth further, weighing on the UK s already weak trade position. Contributions to GDP growth revisions over Q1-Q3 (ppts) GDP growth & forecast (y/y% and ppt contribution) Other Net trade Fixed investment Government spending Household spending Total revision to GDP growth (Q1-Q3 v a year ago) Private consumption Government consumption Total fixed investment Other Net trade GDP growth

2 CBI UK ECONOMIC OUTLOOK QUARTERLY MARCH CBI UK economic forecast 12mth% unless otherw ise stated Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Growth & Consumption Real GDP Manufacturing output Household consumption Government consumption Household savings ratio Investment Fixed investment of which: Total business General government Manufacturing External Trade Exports Imports Current account ( bn) % of GDP Prices CPI RPI RPIX Producer output prices Labour Market Unemployment (ILO, mn) Unemployment rate (%) Unemployment (CC, mn) Claimant count rate (%) Employment (ILO, mn): Average earnings* * Including bonuses Public Sector** Net borrowing ( bn) % of GDP Debt/GDP (%) */16; /17; 217/18 excludes APF Forecast Assumptions Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Global GDP UK Bank Rate Oil prices $ per barrel GBP Trade-weighted index USD/GBP EUR/GBP

3 CBI UK ECONOMIC OUTLOOK QUARTERLY MARCH CBOE VIX volatility index Investment intentions (standardised ) Swathe of non-cbi measures of investment intentions CBI investment intentions composite Concerns over the health of China s economy in particular sparked a large deterioration in global financial markets early in : the FTSE Global All-Cap index remains down by 7% on the start of the year. Looking forward, it is possible that we may see further market volatility one driver may be a divergence in global monetary policy, as the US seeks to raise interest rates further, against more expansionary policy in emerging markets, thus exacerbating capital outflows from EMs. Concerns over the global outlook may also push up risk premia, raising the price of more risky assets. At present, expectations of equity market volatility (as measured by the VIX volatility index) remain relatively low, but are creeping higher. The UK would obviously be exposed to further gyrations in financial markets, with greater uncertainty, lower confidence and negative wealth effects hitting business investment and spending. Domestic demand will be the keystone of growth... Domestic demand remains the key driver of growth in our forecast. In particular, household spending is expected to continue rising strongly, underpinned by strong consumer confidence and with low inflation boosting households purchasing power. Business investment will also see robust growth, especially in the near-term, with our business surveys showing that investment intentions for the year ahead remain solid. The North Sea industry remains the key exception to this, where the hit to profitability from low oil prices has put a real dent into plans for capital spending in that sector....but slower wage growth has taken the edge off But while we continue to expect decent growth in household spending 2.7% in and 1.8% in 217 this is a slight downgrade from our last forecast (2.9% and 2.2%). Much of this stems from an easing off in wage growth over recent months, contrary to our (and other analysts ) expectations of a pick up as the labour market continued to tighten (we explore this further in the In focus section). Also pushing down on the outlook for wage growth is the impact that downward revisions to historic GDP growth data have had on productivity growth over the last couple of years, combined with the fact that output per worker is likely to have fallen sharply over Q4 (by close to 1%). Both lower outturn data on wage growth and the impact of lower productivity have pushed down our forecast for earnings growth (although with inflation lower in the near-term, real earnings should still rise strongly for a time before easing off). This has a modest bearing on our forecast for household spending....and investment growth is lower In 217, slower growth in total fixed investment is also a driver of the downgrade to our forecast. This reflects both lower real incomes growth pushing down on housing investment, and slower GDP growth taking some of the momentum out of business investment. We nonetheless expect strong growth in capital spending over the first half of reflecting the strength in our investment intentions data for the year ahead before slowing to quarterly rates more in line with the pre-crisis GfK consumer confidence barometer () Corporate profitability: net rates of return (%) 1 All PNFCs (lhs) UK continental shelf (rhs) Average weekly earnings deflated by consumer prices index

4 CBI UK ECONOMIC OUTLOOK QUARTERLY MARCH CBI ITS: Manufacturing export order books (standardised ) 2. CPI inflation (y/y%) average over 217 (around.9% in each quarter). Furthermore, business investment still accounts for roughly a quarter of GDP growth in both and 217, making a larger contribution than in our November forecast. Net trade to remain the missing ingredient In contrast to the relatively sound outlook for domestic demand, we still do not expect a material contribution to the economy from net trade continuing the theme of the recovery over the last few years. At present, survey data tends to provide a better steer on trade than the more volatile official data. Our Industrial Trends Survey has shown a small improvement in manufacturers export order books over recent months, coinciding with the decline in sterling against the euro. But overall orders remain subdued and only just in line with average levels. Looking ahead, the recent fall in Sterling (a decline of 8% since end-november ) may continue to provide some relief to exporters. However the decline is relatively small compared to the appreciation seen since (a 21% rise between March and November ), and firms will still be faced with the headwind of softer global momentum. Furthermore, to the extent that the depreciation in the pound reflects uncertainty ahead of the EU referendum, much of the near-term outlook is likely to depend on how this uncertainty evolves over the next few months. Fundamentals alone would otherwise suggest that Sterling should appreciate against the Euro (reflecting more stimulative monetary policy in the Eurozone), and fall Sterling effective exchange rate (12 March =1) Nov forecast Feb forecast slightly against the dollar (with monetary policy relatively looser in the UK). Nonetheless, we do expect some pick up in export growth over 217 particularly, as world GDP growth gradually strengthens. However with domestic demand growing strongly, this will be matched by import growth, such that the contribution from net trade will be negligible. We expect the drag from net trade will be slightly larger in (-.5ppts) compared to our last forecast (-.3ppts), which accounts for some of the downgrade to our GDP growth forecast. Inflation will remain lower for longer... Alongside softer global growth and the deterioration in equity markets, the other key development in the world economy has been a further fall in commodity prices. In particular, oil prices have declined further since our last forecast (by 21%), now trading at close to $4 per barrel. With supply remaining abundant and global demand softening, futures prices point to only a gradual pick up ahead. Renewed falls in commodity prices have led us to revise lower our near-term CPI inflation forecast: we now expect inflation to rise above 1% in late, compared with the beginning of this year previously. Over the next couple of months, we re likely also to see some modest downward pressure from recently announced cuts to utility prices. We expect inflation to converge to the Bank of England s 2% target in mid with a rate rise now unlikely until end- Alongside lower global commodity prices, domestic inflationary pressure has also softened, with inflation likely to be lower for longer, wage growth easing and economic momentum a tad slower. As a result, the impetus for an interest rate rise seems to have waned. At their February meeting, all members of the MPC voted to leave interest rates unchanged, marking the first show of unanimity in six months. Rhetoric from the MPC has also generally turned more dovish several members have pointed to the need to see a definitive pick up in wage growth/unit labour costs before considering a rate rise. 4

5 CBI UK ECONOMIC OUTLOOK QUARTERLY MARCH IN FOCUS: WHY HAS UK WAGE GROWTH SOFTENED? The UK s labour market has been growing strongly......but wage growth has been slowing The UK s labour market has continued to grow strongly. Employment has generally been rising since, and growth picked up over the second half of with employment having risen by a cumulative 383, since then. Similarly, the unemployment rate has been falling and, at 5.1%, is close to several estimates of its natural rate (i.e. the rate of unemployment below which inflation begins to rise). A tightening labour market should, in theory, lead to an acceleration in wage growth (for example, as a smaller pool of available labour leads to more pay bargaining). But wage growth in the UK has actually been slowing: average weekly earnings rose by just 2.1% on a year ago in the three months to January (from a peak of 3% in Q3 ). Excluding bonuses, growth isn t much higher, at 2.2%. The slowing in nominal pay growth has been a key driver of the downgrade to our latest forecast for GDP growth, through bearing down on (albeit still strong) household spending. While low inflation means that pay is still growing strongly in real terms (hence boosting consumers purchasing power), a further slowing in wage growth therefore poses a downside risk to our forecast. The recent tailing-off in earnings growth also reduces the degree of pipeline inflationary pressure in the economy, potentially pushing out the timing of a first rise in interest rates. Indeed, several MPC members have flagged that current rates of wage growth are inconsistent with bringing CPI inflation to the 2% target over an appropriate horizon, and have stressed the need to see a decisive pick up before voting for a rate rise. Some of the easing could reflect a fall in average hours worked So a key factor in appraising the economic outlook is understanding why wage growth has been easing more recently and whether it will continue slowing. Several reasons have been put forward by way of explanation. At least some of the decline could be explained by a fall in average hours worked, particularly among full-time employees (which fell by around 1% in the first eight months of ). Looking further back, average hours worked were actually on a persistent downward trend in pre-crisis years this reversed post-crisis, when they began to rise (by 3% between mid- and end-). The recent fall in average hours is likely in part to reflect the resumption of more normal working practices specifically, people returning to previous annual leave patterns. This is partially corroborated by the difference between the number of hours people usually work, and the average number of hours that they actually work this differential began to narrow in the wake of the financial crisis, before picking up again more recently 1. However, given that average hours have started to rise again in recent data, it may be too early to draw such an inference. A shorter working week, as implied by fewer hours worked, would arguably generate more inflationary pressure in the labour market, as firms would only be able to raise output by hiring more workers rather than through their existing employees working more 1. However, this would crucially depend on prospects for productivity growth, which has been relatively week in recent years. If productivity picks up as we broadly expect, this would dampen inflationary pressure, thus carrying fewer implications for monetary policy. Low inflation may be feeding through to pay awards, depressing wage growth A more significant consideration is whether low inflation is weighing on pay awards and settlements anecdote from our members suggests that this may have been a factor in driving earnings growth lower. This also chimes with reports from the Bank of England s regional agents: in a survey conducted by the agents in early, inflation expectations were expected to be the main downward pressure on total unit labour costs per employee 2. Alongside this, employees may be more willing to accept lower pay awards in the face of low inflation, as real incomes are still growing strongly. Survey indicators of pay or labour cost growth lend some support to this theory. These measures have also been easing, although to a lesser extent than in the official data (which, once again, could be down to measurement issues in the latter). In particular, the BoE agents 1 What s in a week s work? Speech by Martin Weale, 2 January 2 Agents summary of business conditions, Bank of England, February 5

6 CBI UK ECONOMIC OUTLOOK QUARTERLY MARCH scores show that slowing pay growth has been more apparent in the manufacturing sector than in services something that has been broadly reflected in our survey data too. One possible explanation could be that a higher proportion of pay awards in manufacturing are linked to measures of inflation, such as CPI or RPI. However, this is difficult to disentangle from more adverse conditions in the manufacturing sector at present (such as softer global momentum and the previous strength in Sterling), which could also be bearing down on pay 3. The potential impact of low inflation on pay will be a key consideration for the MPC The impact of lower inflation on pay awards would be a more significant consideration for the MPC, as it could be indicative of a downward wage-price spiral low inflation pushing down pay, which turn pushes down inflation further, etc. which would have more direct implications for monetary policy. However, even if low inflation was a dominant factor in pushing down pay growth, this is likely to dissipate as inflation picks up further ahead as we expect (mostly due to the sharp fall in global oil prices falling out of the year-on-year comparison). This should shore up inflation expectations, which would put upward pressure on pay growth. But even accounting for lower inflation, the slowing in pay growth appears to be puzzling in the face of growing skill shortages. Both feedback from CBI members and data from our business surveys flag that these remain high, particularly in certain sectors such as construction and business & professional services. Burgeoning skill shortages should push up pay growth, as employers increasingly bid for relevant staff. Composition of employment growth could be bearing down on pay growth However it is possible that innovative practices to circumvent these skill shortages could, coversely, be bearing down on pay growth. Many of our members facing large skills gaps report recruiting employees with lower levels of experience, and focusing on training them for relevant roles. This is broadly consisent with our survey data, where plans for spending on training & re-training staff remain strong, particularly in manufacturing and consumer services. Furthermore, even if companies are bidding up pay for skilled staff, this may not be feeding through to wages for all employees on payroll. The Bank of England has cited evidence suggesting that companies have addressed hiring difficulties through targeted pay increases for new hires and/or to retain key individuals, rather than making more general increases in wage growth for their staff 3. In summary, the easing in wage growth, and the extent that it will persist, carries important implications for the economic outlook. A continual slowing will eat into household incomes, and thus put downward pressure on consumer spending a sizeable risk to our forecast, given that household spending is expected to drive a large proportion of GDP growth. Further falls in pay rises would also depress inflationary pressure in the economy, at a time when disinflationary influences are already rising (slower world growth, falling commodity prices, softer domestic momentum). This could push out the timing of a first interest rate rise something that several MPC members have already corroborated. Of the factors outlined so far, the extent to which the influence of low inflation and compositional effects (i.e. growth in lower-skilled employment) on pay growth persist, the greater the implications for monetary policy. Risks to wage growth skewed to the upside... But on the whole, the risks to pay growth seem skewed to the upside. The influence of low inflation should begin to fade as it picks up over the course of this year and if skill shortages remain high, the upward influence on pay could become more widespread. Furthermore, we expect the labour market to continue growing strongly ahead such a period of persistent growth should exert greater upward pressure on pay. And if productivity recovers as we expect (albeit only gradually), this will provide further underpin to pay growth. Adding to this, the introduction of the National Living Wage in April is also an upside risk. While the effect on aggregate earnings growth should be modest (the OBR expect average weekly earnings growth to be.4ppts higher to the end of 22), the impact is likely to be greater in certain sectors such as hospitality, retail and care....and we still expect pay growth to pick up ahead As a result, we still expect wage growth to pick up ahead, against the backdrop of continually strong labour market growth, gradual productivity growth and rising inflation. This should continue to underpin firm growth in household spending and, as rising wage growth drives businesses unit labour costs higher, the impetus for an interest rate hike should gain traction. Nonetheless, both the easing in pay growth and weaker productivity has had a significant bearing on our forecast, such that we have revised down our projections for earnings growth in both (2.2%) and 217 (2.2%) relative to November (3.2% and 3.3%). 6 3 What do Agents company visit scores say about the weakness of wage growth?, Bank of England, 15 February

7 CBI UK ECONOMIC OUTLOOK QUARTERLY MARCH KEY INDICATORS WAGE GROWTH UK unemployment rate (%) The unemployment rate (at 5.1%) is now close to many estimates of its natural rate. Average weekly earnings (3m/3m oya%) Nominal Real (deflated using CPI) However, wage growth has been easing although thanks to low inflation, it is still growing strongly in real terms. Average weekly hours worked BoE Agents scores: labour costs per employee (+5 to 5) 39. Full-time (lhs) Total (rhs) Manufacturing Services Slowing wage growth may reflect a fall in average hours worked recently (following an upward trend since ). Skill shortages, CBI surveys (standardised %, 2Q moving average) Skill shortages remain high. Many businesses have cited increased training to circumvent this, but high skill shortages nonetheless present an upside risk to pay growth. Survey data show that wage growth has eased by more in manufacturing than in services. Average weekly earnings incl. bonuses (3m/3m oya%) CBI Feb forecast We expect earnings growth to pick up ahead, partly reflecting the upside risks to pay. But we have downgraded our forecast relative to November

8 CBI UK ECONOMIC OUTLOOK QUARTERLY MARCH CBI INDUSTRIAL TRENDS SURVEY Manuafacturing exports still under pressure January s Industrial Trends Survey showed total new orders edging down slightly following a larger fall over the previous quarter, while output volumes stabilised following a small decline. However, the majority of sub-sectors (eleven out of eighteen) did report falls in output volumes. Export new orders were broadly flat over the three months to January, following the deepest fall for three years over the three months to October. However, only six of the eighteen sub-sectors reported a rise in orders, whereas ten reported a fall, with orders expected to remain near-flat over the coming three months. Manufacturers reported signs of capacity constraints easing further, with the proportion of firms saying that plant capacity will constrain near-term output falling to 9% the lowest since July. Competitiveness abroad remained under intense pressure, with the largest declines continuing to be reported in EU markets (in the latest survey, sixteen of the eighteen sub-sectors reported a decline in competitiveness in the EU, and none reported an improvement). Export output prices continue to post large falls, alongside smaller declines in domestic output prices in average input costs. In the more recent monthly Industrial Trends Survey, manufacturers reported that production dropped sharply in the three months to March, with output volumes declining at the fastest pace since September. However, respondents were considerably more upbeat in their short term outlook for activity, expecting output to rebound sharply over the three months to June. Volume of output Total and export order books above/below normal Total order books Export order books Above normal Below normal Industrial trends survey selected results Oct Jan Apr Jul Oct Jan Business optimism Volume of output - past 3 mths next 3 mths Volume of total new orders - past 3 mths next 3 mths Numbers employed - past 3 mths next 3 mths Average domestic prices - past 3 mths next 3 mths Capital expenditure on: - buildings (12mth forecast) - plant & machinery

9 CBI UK ECONOMIC OUTLOOK QUARTERLY MARCH CBI DISTRIBUTIVE TRADES SURVEY Retail sales growth holds up better than expected Retail sales registered weak growth in year to March, nonetheless beating expectations for growth to come to a halt. Orders placed on suppliers also surpassed expectations grew moderately over the year, and sales for the time of year were considered to be broadly average. Sales growth is expected to pick up somewhat in April, while orders were set to grow at a broadly similar pace. Elsewhere, wholesaling reported slower sales volumes growth in the year to March while motor trades saw sales volumes rising strongly, beating expectations of a slight slowdown. Retail sales volumes vs a year ago () Reported 3 month moving average By sector : retail sales volumes vs a year ago () Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Distributive trades survey selected results Retailing Aug Sep Oct Nov Dec Jan Feb Mar Volume of sales versus year ago Volume of sales - 3 month moving average Wholesaling Volume of sales versus year ago Volume of sales - 3 month moving average Motor Traders Volume of sales versus year ago Volume of sales - 3 month moving average

10 MARCH CBI UK ECONOMIC OUTLOOK QUARTERLY MARCH CBI SERVICE SECTOR SURVEY Mixed picture across services sectors Conditions in consumer and business & professional services diverged in the three months to February. Sentiment in consumer services continued to improve, but was unchanged in business & professional services. Business & professional services firms reported that business volumes were flat, while profitability fell. By contrast, the continued expansion of business volumes in consumer services underpinned a further improvement in profitability, albeit at the slowest pace for two years. Looking ahead, volumes growth is expected to pick up in both sub-sectors over the quarter to May, but rising costs will help keep profits unchanged across the sector. Despite a more cautious mood among services firms, employment growth is expected to remain robust and investment intentions also held firm. Consumer services business volumes () past 3 months next 3 months Business & professional services business volumes () past 3 months next 3 months Service sector survey selected results Nov Feb May Aug Nov Feb Consumer Business optimism Volume of business Overall profitability Numbers employed Capital expenditure on: - Land & buildings (next 12mths) - Information technology Business & Professional Business optimism Volume of business Overall profitability Numbers employed Capital expenditure on: - Land & buildings (next 12mths) - Information technology

11 CBI UK ECONOMIC OUTLOOK QUARTERLY MARCH CBI/PwC FINANCAL SERVICES SURVEY* Sentiment deteriorates for the first time in over three years Financial services firms were less optimistic about the general business situation in the quarter to March the first deterioration in sentiment since. However, business volumes continued to expand at a solid pace, driven by demand from private individuals and the corporate sector. Profitability also continued to rise, albeit at its slowest rate in almost two years. Similar growth in both volumes and profitability is expected next quarter. But firms see financial market instability, competition and macroeconomic uncertainty as key challenges in the year ahead. Against this background, employment is expected to be flat over the next quarter, with falling headcount in banking offsetting jobs growth in other sectors. And while firms continue to plan for higher investment IT, investment in other areas is set to be cut back. * survey conducted in partnership with PwC Business volumes Optimism past three months next three months CBI/PwC Financial services survey selected results Dec Mar Jun Sep Dec Mar Business optimism Volume of business - past 3 mths next 3 mths Value of fee, commission, or - past 3 mths premium income - next 3 mths Total operating costs - past 3 mths next 3 mths Overall profitability of business - past 3 mths next 3 mths Numbers employed - past 3 mths next 3 mths Capital expenditure on: - Land & buildings (12mth forecast) - Information technology

12 CBI UK ECONOMIC OUTLOOK QUARTERLY MARCH FURTHER INFORMATION CONTACT DETAILS The CBI s economic analysis team monitors and analyses developments in both the UK and international economies. This intelligence underpins the CBI s policy and lobbying work, and also acts as an important resource to members. Member companies are invited to contact relevant members of the economics team for further information on the content of this publication, or any other economic material of relevance. We regret that the CBI s enquiry service does not extend to non-members. Anna Leach Alpesh Paleja Head of Economic Analysis Principal Economist UK forecast DL: +44 () DL: +44 () E: anna.leach@cbi.org.uk E: alpesh.paleja@cbi.org.uk Charlotte Dendy George Brown Economist Eurozone Economist Emerging markets DL: +44 () DL: +44 () E: charlotte.dendy@cbi.org.uk E: george.brown@cbi.org.uk Ben Jones Mia Andersson Senior Economist US and Japan Senior Policy Adviser DL: +44 () DL: +44 () E: ben.jones@cbi.org.uk E: mia.andersson@cbi.org.uk If you wish to participate in or require further information on our various business surveys, please contact: Jonathan Wood Nicola Grimwood Head of Survey Management Senior Survey Coordinator DL: +44 () DL: +44 () E: jonathan.wood@cbi.org.uk E: nicola.grimwood@cbi.org.uk Previous editions of this publication, and further examples of our analytical and survey work can be found on our website: Economics publications & services The CBI s economics team take advantage of the organisation s diverse contacts with British business to help build up an accurate assessment of the latest developments in the UK and international economy. The team s work is vital since official statistics, where available, are often slow to be published and are subject to revision. We publish a quarterly International Economic Outlook, outlining our assessment of global conditions, and a separate UK Economic Outlook containing more detailed analysis and forecasts for the UK. We also regularly release updates and focus articles on global economic issues of macroeconomic relevance. In addition, the team also publishes the unique CBI business surveys, covering manufacturing, distribution, consumer, business & professional services, financial services and SMEs. 12