EY ITEM Club Outlook for financial services

Transcription

1 EY ITEM Club Outlook for financial services Minds made for empowering financial services Summer 2018 ey.com/fsitemclub

2 About this report The EY ITEM Club: Outlook for financial services examines the implications of the EY ITEM Club s economic projections for the financial services sector. EY is the sole sponsor of the EY ITEM Club, which is the only non-governmental economic forecasting group to use the HM Treasury model of the UK economy. Its forecasts are independent of any political, economic or business bias. In conjunction with ITEM s Chief Economist Howard Archer, Oxford Economics is responsible for producing the forecasts and analysis provided in ITEM s forecast reports. Oxford Economics is one of the world s foremost independent providers of global economic research and consulting using unique global economic models. EY is a leader in shaping the financial services industry We are a global leader in assurance, tax, transaction and advisory services. Over 30,000 of our people are dedicated to financial services, serving the banking and capital markets, insurance, and wealth and asset management sectors. At EY Financial Services, we share a single focus to build a better financial services industry, not just for now, but for the future. Together let s build a better working world. ey.com/fsminds 2 EY ITEM Club Outlook Summer 2018

3 Contents Macroeconomic overview Banking Insurance Wealth & Asset Management EY ITEM Club Outlook Summer

4 Macroeconomic overview A weakening economic outlook presents a challenge to financial services firms The first quarter of 2018 saw an expansion of just 0.2% in the UK s gross domestic product (GDP), one of the weakest results in over five years. Growth may have been affected by the severe winter weather, but we have seen few convincing signs of a strong rebound since. Several factors, including slowing Eurozone growth and rising oil prices, mean that this forecast is less encouraging than the spring edition six months ago. We now expect GDP to grow by 1.4% this year. This is down from our previous prediction of 1.7% and well below historic trends and current global averages. That sluggish performance will make it difficult for financial services companies to grow and support the economy as much as they would like. Consumers face a renewed squeeze on disposable income and spending Inflation continues to decline, falling to 2.4% in April and May from a peak of 3.1% last November. But unfortunately, the next few months are likely to see a renewed squeeze on households spending power as oil reached a 3.5-year peak of $80 per barrel in May, and higher energy prices will take effect over the summer. On the upside, record levels of employment should provide support for consumption. Set against that, sluggish wage growth means that real household disposable incomes will grow by just 1.3% this year and next. The household saving ratio also reached a 50-year low in The resulting need to rebuild household savings means that consumer spending is only expected to grow by 1.2% this year and 1.5% in % 2.4% 2.4% GDP We now expect GDP to grow by 1.4% this year. This is down from our previous prediction of 1.7% and well below historic trends and current global averages. Inflation Inflation continues to decline, falling to 2.4% in April and May from a peak of 3.1% last November. Mortgage lending Mortgage lending will climb 2.4% this year and experience its weakest growth since 2013 next year, 1.8%. 4 EY ITEM Club Outlook Summer 2018

5 whilst cooling global growth and Brexit uncertainties raise questions over exports and investment In 2017, the weak pound and buoyant worldwide growth allowed net trade to make a sizable contribution to GDP. But whilst the US economy remains strong, the outlook for exports is increasingly clouded by growing global protectionism and slowing growth in the Eurozone the UK s biggest export market. We now expect the Bank of England to raise the interest rate only once this year The Monetary Policy Committee s focus on Q2 s rebound in consumer spending suggests that a further hike in the Bank Rate could be looming. We expect a 25 basis point rise to 0.75% in August, although weak pay growth and Brexit uncertainty could delay that decision until November. Our forecast assumes that Brexit uncertainty will ease this year as the UK and EU move toward an agreement on withdrawal and transition. That would push up sterling but should reduce headwinds to inward investment. However, there are clear downside risks to this scenario. Political friction in the UK and the slow pace of negotiations mean that a no-deal Brexit can t be ruled out. The resulting fall in sterling might provide a short-term boost to exports, but such an outcome could have serious negative implications for the economy and the financial services sector in particular. 4.7% 4.1% 1.2% Business lending We forecast a 4.7% expansion in the stock of business lending this year, with further growth of 2.5% in 2019 Consumer credit We expect consumer credit growth to slow to 4.1% and 1.9% this year and next. Consumer spending Consumer spending is set to climb by just 1.2% this year the lowest rate since EY ITEM Club Outlook Summer

6 Banking Dampened household incomes will hold back demand for lending this year The next two years will see real household incomes limited by still-high inflation and slow employment growth. This will keep a lid on household lending growth. Meanwhile, businesses preference for nonbank finance will continue, although it should weaken slightly this year. These factors mean that banks total lending is now expected to grow by just 1.7% this year and 1.5% in Household debt stabilises, whilst interest burden falls to a new record low % Debt as % of income (LHS) Source: EY ITEM Club Interest payments as % of income (RHS) The mortgage market is particularly subdued The past few months have been quiet ones for the housing market. This reflects pressure on real incomes, stretched affordability and expectations of higher interest rates. As a result, mortgage lending grew by just 3.4% in the year to April 2018, around a third of the average. We expect this stable but sluggish picture to continue, with net mortgage lending climbing 2.4% this year and 1.8% in 2019 the slowest pace since Mortgage rates remain near historic lows, despite last November s Bank Rate hike. But even with house prices growing slowly, the ratio of prices to average earnings remains high. According to Halifax, this was 5.6 in May, well above the 35-year average of 4.2. and although consumer credit keeps growing, it too will begin to cool this year Consumer credit growth has exceeded our predictions, growing by 8.8% in the year to April This is slightly lower than November s peak of 10.9%, but that is largely due to weaker car financing, a market where most banks are largely inactive. Personal lending and credit card debt continue to expand, recording growth of 8.7% and 8.9%, respectively, during April. % Despite this, we expect consumer credit growth to slow to 4.1% and 1.9% this year and next. This dramatic shift in momentum reflects a combination of demand- and supply-side pressures. On the demand side, we forecast consumer spending to climb by just 1.2% this year the lowest rate since Households need to bring their spending levels back in line with real incomes, especially in the light of 2017 s record low household savings ratio of 4.1%. Meanwhile, the Bank of England s Credit Conditions Survey for the first quarter of 2018 shows that a net balance of nearly 40% of lenders expect the supply of credit to tighten. The first quarter also saw a year-on-year fall from 30 to 26 months for average interest-free credit card transfer periods. The outlook for business credit looks modest, despite banks willingness to lend Growth in business lending remains relatively soft, following a contraction of 4.3% in the stock of business loans during The year to April saw modest lending growth of 2%, but if repayments are taken into account, the stock of loans only increased by 1% over that period. This may seem odd, given solid corporate profitability and the 6.2% expansion in total UK corporate debt during The uncertain investment outlook is one factor, but the leading consideration is the continuing popularity of nonbank finance. Investors thirst for yield is generating sustained demand for UK corporate bonds, with nearly three-quarters of net corporate borrowing since 2007 coming via securities issuance. However, a 30 basis point increase in investment grade sterling corporate bond spreads since early 2018 suggests that banks could have a fresh opportunity to increase their lending, including to SMEs. We forecast a 4.7% expansion in the stock of business lending this year, with further growth of 2.5% in A soft outlook for lending growth % year Consumer credit Lending to companies Mortgage lending Source: EY ITEM Club/Haver Analytics Forecast 6 EY ITEM Club Outlook Summer 2018

7 Banks face new funding pressures and a fresh surge in PPI costs The end of the Bank of England s Term Funding Scheme, which provided cheap financing to commercial banks, in February means that banks may have to compete more aggressively for customer deposits. With competition making it harder to charge borrowers more and the average interest rate on new deposits higher than the Bank of England rate, the loss of cheap funding may weigh on banks profit margins, although the option of tapping the securitisation market could reduce upward pressure on costs. Moreover, the potential for increased transparency resulting from the FCA s review into retail banking business models could, in the long run, reduce the income of some banks by encouraging depositors to switch providers. Meanwhile, the implications of last year s Plevin ruling on compensation for mis-sold payment protection insurance may be behind rising compensation costs in the run-up to the August 2019 deadline for claims. The six months to March 2018 saw monthly compensation average 376m, 60% up on the 233m averaged in the same period in This pushed up the cumulative cost since 2011 to almost 31b. And the recent legal ruling on commission thresholds could, if it creates a precedent, result in a significant hike in the total compensation bill. Banking sector recap Total assets ( b) 6,995 7,332 7,460 7,501 7,666 7,903 Total loans ( b) 6,077 6,372 6,566 6,666 6,826 7,042 Business/corporate loans ( b) Write-offs (% loans) Consumer credit ( b) Write-offs (% loans) Residential mortgage loans ( b) 1,155 1,205 1,234 1,256 1,292 1,329 Write-offs (% loans) Deposits (% year) Loans/deposits (%) Total income ( b) Source: EY ITEM Club EY ITEM Club Outlook Summer

8 Insurance Modest growth in real incomes is welcome but will give limited support to non-life premiums Following a dismal 2017, when average inflationadjusted incomes fell by 0.6%, 2018 holds slightly more encouraging news for big-ticket spending and non-life premium growth. Unfortunately, we expect higher petrol prices and utility bills to weigh on household finances, limiting real income growth to 1.3%. That is a long way off the 3.1% average annual increase seen between 1997 and This weak performance means that non-life premium growth will be limited to 3.2% this year and 3.1% in Motor insurance prices have started to fall % year Home contents CPI inflation Motor insurance Source: EY ITEM Club/ONS Motor insurance faces a mixed outlook Motor insurance faces some specific head winds. The most obvious is the continuing plunge in sales of new diesel vehicles. Slowing growth in Personal Contract Purchases is another cooling factor, together with signs of a gradual shift away from car ownership. Car registrations are forecast to fall by 4.2% this year, following 2017 s drop of 5.7%. We only expect to see modest growth of 1% in On the face of it, a 3.5% fall in motor pricing during the year to May is further bad news for insurers. This was the second consecutive decline and contrasts with the 11% rise recorded in May However, lower prices do not necessarily indicate a turn in the rates cycle. Reforms to the Ogden discount rate have so far had a softer impact than expected. and home insurance markets remain tepid The sluggish home insurance market is another contributor to slow non-life growth. Stretched affordability for potential buyers and a limited supply of properties coming to market mean that we expect housing transactions to rise by little more than 1% a year from 2018 to For comparison, annual transaction growth averaged 5.9% over the previous five years. Housing transactions are forecast to see only modest growth 000s Source: EY ITEM Club/Haver Analytics Prospects for asset markets are becoming less favourable to life companies Forecast The softening global growth outlook, illustrated by the Eurozone slowdown and the rising risks of protectionism, suggests that the performance of equity markets this year will not replicate that of And although bond yields should climb as the Bank of England raises rates, life insurers won t escape the pressures of a low-rate world for some time. UK yields remain surprisingly weak, compared with US equivalents, and we anticipate just one 25 basis point UK rate rise this year, with two more in As the world moves toward monetary tightening, we expect the 10-year gilt yield to average 2.6% between 2018 and In comparison, 10-year gilts were yielding just under 1.3% at the start of July, down from a recent peak of 1.6% in April. We forecast life premiums to rise by an annual average of 3.4% between 2018 and EY ITEM Club Outlook Summer 2018

9 Demographic changes could provide some support for profits Overall, we forecast insurance profits to grow by an average of around 6% over the next few years, driven in part by increasing bond yields and improving claims ratios. The fact that the ONS sees UK life expectancy gains as having tailed off since 2011 is troubling but could boost profits by enabling insurers to adjust their mortality assumptions. In time, this trend could also reduce corporate pension scheme deficits, encouraging buyouts by specialist insurers. though the impact of policy changes remains unclear Looking ahead, policy changes will continue to affect the life sector. The introduction of pension freedoms led to over 1.5 million personal pension pots being accessed between April 2015 and September That marks a substantial shift toward drawdown and away from annuities. The FCA continues to focus on safeguarding customer outcomes. The recent Retirement Outcomes Review made it clear that providers should expect ongoing change, starting with the launch of a consultation on consumer protection and competition in the retirement income market. The ongoing review into Defined Benefit to Defined Contribution transfers is likely to put in place more stringent controls on transfers into personal pensions or drawdown products, dampening the market. Finally, 2018 has seen the first planned rise in autoenrollment contribution rates, without significant impact on opt-out rates. If 2019 s larger rise also goes through smoothly, new money into pension schemes should see a significant boost. Insurance sector recap Life gross premium ( b) % year Life gross claims payments ( b) Life claims ratio (%) Non-life gross premium ( b) % year Non-life gross claims payments ( b) Non-life claims ratio (%) Net profit ( b) Source: ITEM, OECD, Swiss Re EY ITEM Club Outlook Summer

10 Wealth & Asset Management 2017 delivered the strongest rise in AUMs since saw the FTSE 100 Index record a rise of 14.7%, its biggest since the start of the decade. This, together with buoyant global markets and a further weakening in sterling, helped UK assets under management (AUM) rise by 17.4% during the year. That was the strongest growth since 2010 and the second year running of double-digit expansion. At the end of 2017, AUM reached almost 1.3t, equivalent to 62.4% of UK GDP. As recently as 2016, that figure was less than 1t. Strong AUM growth in 2016/17 is forecast to cool b AUMs ( b) GDP ( b) Source: EY ITEM Club/Haver Analytics Forecast but cloudier global prospects suggest less strength ahead Unfortunately, this strength is unlikely to be repeated in Sterling s retreat against the dollar in recent months will support UK equities, many of which have significant foreign earnings. However, we forecast the pound to stage a modest recovery over the coming year. This reflects a gradual rise in UK base rates expected to start in August and our hopes for a gradual reduction in Brexit-related uncertainty. If proved correct, that would reduce the mechanical boost to equities from sterling s weakness. A more mixed outlook for the world economy also suggests that global asset prices will perform less well than we previously forecasted. The US economy continues to perform strongly, but the Eurozone has struggled to rebound from its slowdown in early 2018, and the growing risks of a global trade war are already dampening asset valuations. It s worth noting that there are few signs of over-valuation; the FTSE s priceearnings ratio at the end of June was 13.6, well below the 15-year average of almost 16. Even so, a projected average annual rise of 4.8% in the FTSE All Share Index between 2018 and 2021 is less than half the figure achieved in 2016 and So whilst we expect some capital to shift from bonds to equities, the extent of the rotation will be modest limiting the sector s profitability growth. 10 EY ITEM Club Outlook Summer 2018

11 Auto-enrollment and high employment offer some potential opportunities On the upside, the asset and wealth management sector is well-positioned domestically to benefit from increasing mandatory saving. April 2018 saw employers auto-enrollment pension contributions by employees rise from 1% to 2%, with a further increase to 3% planned for April The DWP now expects auto-enrollment to add 19.7b per year to pension savings by , equivalent to around 1% of UK GDP. Although some savers might opt out as contribution rates rise, inertia suggests that most are unlikely to do so without a triggering event such as a job change. High levels of UK employment will bolster inflows from auto-enrollment, and we expect AUM to receive a boost as households face up to rebuilding saving ratios from 2017 s record low levels. Set against that, a slowdown in the growth of households financial assets could create head winds to inflows. The level of UK household wealth is already high by historical standards. Net of financial liabilities, it equated to 352% of household incomes in the first quarter of 2018, compared with an average of 282% since Household financial assets grew at just 3% in the first quarter of 2018, down from 11.2% in the third quarter of 2016 and following a rare decrease of 1.2% in the final quarter of the same year. AUMs forecast sees shift towards equities b Money market Fund of funds Property Mixed Equities Bonds Forecast Source: EY ITEM Club/Broadridge Wealth & Asset Management sector recap Total Assets under management ( b)* 1,086 1,275 1,302 1,327 1,399 1,498 % year Bonds ( b) Equity ( b) Fund of Funds ( b) Hedge ( b) Mixed ( b) Money Market ( b) Property ( b) *UCITS and non-ucits assets Source: EY ITEM Club, Broadridge EY ITEM Club Outlook Summer

12 EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organisation, and may refer to one or more of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organisation, please visit ey.com. The UK firm Ernst & Young LLP is a limited liability partnership registered in England and Wales with registered number OC and is a member firm of Ernst & Young Global Limited. Ernst & Young LLP, 1 More London Place, London SE1 2AF Ernst & Young LLP. Published in the UK. All Rights Reserved. About Oxford Economics Oxford Economics was founded in 1981 to provide independent forecasting and analysis tailored to the needs of economists and planners in Government and business. It is now one of the world s leading providers of economic analysis, advice and models, with over 700 clients including international organisations, Government departments and central banks around the world, and a large number of multinational blue-chip companies across the whole industrial spectrum. Oxford Economics commands a high degree of professional and technical expertise, both in its own staff of over 80 professional economists based in Oxford, London, Belfast, Paris, the UAE, Singapore, New York and Philadelphia, and through its close links with Oxford University and a range of partner institutions in Europe and the US. Oxford Economics services include forecasting for 200 countries, 100 sectors and 3,000 cities and sub-regions in Europe and Asia; economic impact assessments; policy analysis; and work on the economics of energy and sustainability. The forecasts presented in this report are based on information obtained from public sources that we consider to be reliable but we assume no liability for their completeness or accuracy. The analysis presented in this report is for information purposes only and Oxford Economics does not warrant that its forecasts, projections, advice and/or recommendations will be accurate or achievable. Oxford Economics will not be liable for the contents of any of the foregoing or for the reliance by readers on any of the foregoing. EYG no Gbl In line with EY s commitment to minimise its impact on the environment, this document has been printed on paper with a high recycled content. This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax or other professional advice. Please refer to your advisors for specific advice. ey.com/ukfs