Outlook Spring 2015 The public to private sector shift The Northern Ireland economy enjoyed a relatively strong 2014, with increasing employment levels supporting high levels of consumer and business confidence. Furthermore, the positive shock of lower oil prices has created a boon for consumers and businesses alike. As a consequence 2015 should also deliver relatively strong economic growth. Given the surprising Conservative party majority (albeit slender) in the general election, the key trajectory of government spending over the period of this new Westminster parliament remains on a downward trend. Therefore the central theme of the UUEPC Spring 2015 forecast is one of austerity and its likely impact on growth. In contrast to many other forecasts, UUEPC expect economic growth in the medium term to slow in Northern Ireland (a feature of our forecasts for some time) as the private sector moves to take up the slack created by lower Government spending. Key Forecasts Northern Ireland 2015 2016 2017 2018 GVA (1) growth rate 1.9% 1.1% 1.0% 1.3% Unemployment rate (2) 4.3% 4.4% 4.5% 4.9% Employment growth rate 0.7% 0.6% 0.4% -0.2% House price growth 7.1% 5.7% 5.6% 5.5% United Kingdom and world forecasts 2015 2016 2017 2018 GVA (1) growth rate 2.2% 1.5% 1.1% 1.3% Unemployment rate (2) 3.2% 2.7% 2.7% 3.0% Interest rates (3) 0.5% 1.5% 2.5% 2.5% Inflation (4) -0.1% 2.9% 2.7% 2.4% House price growth 5.0% 5.7% 6.7% 6.6% World Trade 4.1% 5.6% 5.5% 5.1% Note 1: Gross Value Added (GVA) is the preferred measure of economic activity. It is similar to Gross Domestic Product (GDP) but excludes the impact of taxes and subsidies (most notably VAT). Note 2: Claimant count rate as a % of 16 64 population Note 3: Bank of England base rates Note 4: UK Consumer Prices Index (CPI)
In this edition The public to private sector shift strong levels of economic growth underpinned by favourable macroeconomic conditions such as falling oil prices is evident in the recent economic announcements and this has given rise to an increase in consumer and business sentiment, but greater pressure on government spending is projected to see growth soften in the medium term. Wider global environment three macro-economic factors will have a significant impact on NI and UK economic performance. These are the sterling exchange rate, continued uncertainty in the Eurozone and the fall in oil prices. This edition of the outlook discusses the impact these factors could have on the economy locally. Northern Ireland Sectoral Outlook the impact of local, national and international economic factors on individual sectors of the local economy shows a very mixed picture. Stronger growth is forecast in manufacturing and the private sector more generally, but with job losses expected in the public sector. The public to private sector shift The UUEPC forecast for 2015 has remained unchanged since its Autumn 2014 outlook. Consumer confidence has been rising since the start of the year after a slight drop in the final quarter of 2014 and the latest Purchasing Managers Index (PMI) survey suggests a return to growth for Northern Ireland business. This is also consistent with reported increases in the level of bank lending. Historically confidence surveys have provided an accurate short term forecast of economic activity, so these latest results represent good news. Looking beyond 2015, the UUEPC forecasts a reduction in economic growth. Lower levels of government spending, an end to falling prices and rising interest rates (albeit modest) will all have a negative impact. Employment growth of approximately 12,400 net new jobs is forecast over the next four year period, which contrasts with over 27,000 jobs created between 2012 and 2014. The reduction in public sector employment explains the sharp fall in job creation, but encouragingly almost 21,000 private sector jobs are expected to be created over the forecast period, significantly more than the 14,000 created in the recovery period to date. This reflects a lag in recruitment following the impressive inward investment performance over the last 12 to 24 months. At a national level the UUEPC forecast is more prudent than the Office of Budget Responsibility (OBR) outlook. A more optimistic scenario could be envisaged but this will require a number of factors to occur. These include: A significant increase in wage growth; Less severe government spending cuts; and Lower inflation than projected allowing interest rates to remain low for longer. If these factors materialise then stronger economic growth could be anticipated. Will earnings start to increase at levels significantly above inflation? One of the key drivers for economic growth anticipated by the OBR is wage inflation (as workers earnings rise they increase their spending thus boosting economic growth). The OBR forecast wage growth increasing from 1.5% in 2014 to 4% in 2019 at a time when job growth is expected to fall to below 1% p.a.. These are substantial increases given the OBR s benign inflation outlook (Figure 1). This level of wage inflation assumes an economy approaching full capacity and requires a willingness of firms to increase pay settlements at levels not seen since before the financial crisis. The OBR indicated in March that it now expects remaining spare capacity in the UK economy to be eliminated by late 2017, this is approximately 18 months earlier than it forecast in December. Given the additional supply of labour from public sector job losses, the potential from inward migration and the desire of firms to rebuild margins, the UUEPC forecast is for more modest wage growth at the aggregate level. Furthermore, increasing productivity is required to support the level of wage growth anticipated by the OBR. In 2014, the Bank of England estimated that UK output per hour was 16% below its pre-crisis trend and at the economy wide level, productivity growth is a pre-requisite to wage growth. The UUEPC will be monitoring the earnings and productivity statistics closely to inform future forecasts.
Will austerity be less severe than anticipated? Prior to the general election, the OBR indicated a rollercoaster profile for implied public services spending through the next Parliament [with] a more significant squeeze on real spending in 2016-17 and 2017-18 than anything seen over the past five years followed by the biggest increase in real spending for a decade in 2019-20. The detailed post-election spending plans have yet to be developed, but it is the UUEPC view that government spending reductions may be less severe than those set out by the OBR (although this more optimistic scenario is not assumed in the current UUEPC baseline forecast). This in turn would reduce the number of anticipated redundancies and offer a boost to low growth forecasts. However, at present the UUEPC forecast assumes the March 2015 OBR spending cuts will be delivered. Figure 1: UK Jobs growth vs. Wage growth (%p.a) Ironically, if economic growth is stronger than anticipated then there is less pressure for spending reductions, however if growth is harder to achieve then spending reductions become more likely, thus becoming either a virtuous or vicious cycle. This is the result of a macro-economic policy that does not act counter-cyclically when facing a demand led recession. Will interest rates stay low for longer? UK interest rates have been at their record (emergency) low levels of 0.5% since March 2009 and the current forecast in the Bank of England s May 2015 Quarterly Inflation Report is for a rise in rates mid-2016. Although low interest rates penalise savers, given levels of indebtedness in the economy, higher rates would have a negative impact on consumer spending and business investment. Figure 2: UK Inflation/ Consumer Price Index (%) Wider global issues Ultimately the decision to raise rates will be based on inflation expectations. With the Consumer Price Index (CPI) currently sitting at -0.1%, there is no immediate need to increase interest rates (Figure 2). Although prices overall have been steady over the last 12 months, the price of goods have fallen by approximately 2% and the cost of services have risen by the same amount, approximately 2%. Looking in slightly more detail, food prices have fallen most significantly and education costs have increased the most (Figure 3). The big inflation related story over the last 12 months has been the fall in oil prices. This is discussed in more detail further below but the cost of oil and energy feeds through to the cost of most goods. Therefore the approximate 50% fall in the price of oil has been an important element in the latest fall in the CPI. The consensus view from industry experts suggests an oil price in the region of $70 a barrel for the next 12 months. However as the oil price reduction falls out of the CPI calculation and prices start to increase, this will put upward pressure on inflation. This is a factor in the UUEPC forecasts in which inflation is higher than the OBR (and other) forecasts. Usually, talk of deflation raises fears in policy making circles that the economy could fall into a deflationary spiral as consumers delay spending in the expectation that prices will continue to fall. This is less of a concern on this occasion as it is anticipated that deflation is a temporary occurrence resulting from lower costs (most notably oil) rather than a lack of demand requiring firms to cut prices in order to sell stock. The demand deficiency scenario would be of greater concern but its role in the current cause of deflation is less evident. In an inter-connected world, international events have a significant impact in local markets. Over the last 12 months there have been a number of major macro-economic factors which are shaping economic performance and policy. The strength of sterling The exchange rate is a useful measure of international market confidence in the strength of a nation s economy. Therefore a strong currency should be celebrated as a sign of economic strength. On that basis the markets are showing significant confidence in the US economy with the dollar gaining almost 11% against sterling and a staggering 27% against the Euro in the last 12 months. The dollar also benefits from its safe haven status in times of economic uncertainty. The UK s relative economic strength is also notable in terms of sterling s 13% appreciation against the euro, since May 2014 (Figure 4). However confidence in a currency is not necessarily positive for the wider economy. A strengthening currency signals that the market is anticipating an increase in interest rates and also reduces the competitiveness of exports. Looking forward, the European Central Bank announced in January its own Quantitative Easing programme to purchase 60 billion of bonds each month until at least September 2016. This would suggest that Eurozone interest rates will remain unchanged (at 0.05%) for some time and beyond the time when both US and UK interest rates are likely to start increasing. As a result there is no strong basis to assume a strengthening Euro exchange rate in the short term. Overall, the strong dollar is good for NI exports but the weak euro is creating competitive pressures, particularly for our manufacturers. This impacts both export markets where NI goods and services are more expensive, but also domestic markets (including GB). For example, Republic of Ireland agri-food exporters can now sell into the UK market at a more competitive price point.
Continued uncertainty in the Eurozone but growth is starting to emerge A further factor impacting the euro exchange rate is the wider uncertainty surrounding the long term membership of some countries in the Eurozone project. The focus for some time has been on Greece and the recent election of a strongly anti-austerity coalition which has pledged to halt a number of the economic reforms which the previous Greek Government had initiated. Looking from the outside in, the level of outstanding Greek debt is too large for their economy to service and the scale of austerity being imposed is having a crippling effect (unemployment is still at approximately 25%). Whilst many of the economic reforms still need to be progressed, the current position is not sustainable and will only result in Greece lurching from one debt repayment crisis to another. The current negotiations between Greece and its Eurozone creditors need be viewed in a wider context. The EU has the economic strength to allow Greece to restructure its debt but importantly, any deal that Greece secures could also be demanded by other indebted nations. Unfortunately the EU does not have the economic strength to allow larger economies such as Spain or Italy to restructure its debts. There are no quick fixes for the issues faced in the Eurozone which will most likely result in continued uncertainty for the medium term at least. in shale oil production in the US and the subsequent decision by Saudi Arabia to maintain their current production levels. Historically Saudi Arabia would have cut back production to maintain higher prices, but on this occasion they have chosen to maintain their market share and the resultant over-supply has reduced prices. Looking forward, international reports indicate that the Saudi Government has taken a position it is prepared to defend beyond the short term. Furthermore oil industry analysis suggests that the average US shale oil company requires an average oil price of $70 per barrel just to breakeven, therefore one could assume that Saudi Arabia is targeting a price in that range. This would squeeze higher cost production and supply levels should then start to fall back. In the absence of a major geopolitical event, the current price range seems the likely level for next 12 months at least. From a domestic perspective, economic uncertainty in the Eurozone is impacting economic growth in a number of ways. Low growth depresses demand in our largest export market, the lower value of the Euro makes our exports more expensive in that market and Eurozone imports are also more competitive in our domestic market. Encouragingly, there is also some good news. The Eurozone has moved out of deflation and job levels have started to increase in a number of countries. Although Greece dominates the media coverage, underlying data suggests a pick-up in growth. German job growth in 2014 was 2%, Spanish employment increased by an encouraging 3.6% and Italy by 1.6%. This growth is only just emerging but if it proves sustainable, it could provide momentum for improved economic performance across the wider EU. The collapse in oil prices The big macro story to emerge since the last UUEPC economic outlook is the very significant fall in oil prices (which no economic forecaster had anticipated). In the last 12 months, Brent Crude has fallen from a peak of $115 per barrel to a low of $46 in January 2015. Since then prices are recovering and are now trading in a range between $60 and $70 per barrel (Figure 5). As net energy importers, this has delivered an economic boost to the UK and Republic of Ireland. From the consumer perspective, this is equivalent to a tax cut and increases disposable income for consumer spending. From a business perspective input costs are reduced which in turn eases pressure on profit margins. The greatest beneficiaries will be the large energy users in the agriculture, manufacturing, utilities and transport sectors. This fall in prices has been driven by a wide range of geo-political circumstances. However, the two main factors have been the significant level of investment Figure: 3: CPI Inflation by item (Apr 2014 - March 2015 % change) Figure 4: Sterling, Dollar and Euro exchange rates $ Figure 5: Crude oil prices, Brent ($ per barrel)
Sectoral Outlook Production and Manufacturing Performance in the agriculture sector has been reasonably strong and employment levels held up throughout the recession and recovery period. However the sector is currently facing a number of challenges. In particular, milk prices are putting pressure on dairy farmers and the strength of sterling is impacting food exports. Manufacturing has seen the largest growth in private sector jobs since the start of the economic recovery and it is anticipated growth should continue, even in a challenging exchange rate environment. Interestingly NI manufacturing is performing more strongly than in other parts of the UK, if NI manufacturing had only grown at average UK rates then 4,700 fewer jobs would have been created since 2012. Manufacturing also has the benefit of being one of the sectors least impacted by Government spending restraint. Construction The construction sector is experiencing modest growth, in part explained by the now established trend of local firms enjoying success in bidding for overseas contracts, predominantly GB but also internationally. Locally, a sustained increase in house prices continues to give confidence and activity levels are positive (NISRA reported an 8% rise in NI house prices in 2014 and a 24% jump in sales). However publicly funded construction activity is likely to come under continued pressure as austerity measures are implemented. Private sector services Northern Ireland has had an excellent record in attracting foreign direct investment, therefore it is disappointing that jobs growth in some of the targeted higher value added service sectors has not been higher. If the professional services and ICT sectors had grown at UK rates since 2012, then an additional 4,800 jobs would have been created. Looking forward, growth in areas such as professional services should be stronger as the jobs which have already been promoted/ announced are created. The retail sector continues to experience pressures from a number of areas, but lower inflation should provide a boost to consumers and in turn the retail sector. Increased activity in the housing market also creates associated activity in the retail sector and professional services as people make larger purchases but also increases confidence in the economy more generally. Public sector services Austerity will be the new normal for most of the rest of this decade. From an employment perspective small increases are anticipated in the health sector and it will be interesting to see the extent to which the private sector will step in and take advantage of opportunities that become available as funding is stretched in public sector provision. Northern Ireland is still catching up with other parts of the UK in terms of public sector job losses. Since 2012 Public Administration employment has increased by 1,300, however if we had followed the same path as the rest of the UK, employment in Public Administration would have fallen by 2,800. The forecast is for a loss of 8,400 jobs across the public sector over the next 4 years as headcount reductions, rather than changing pay and conditions, is the chosen response to reduced public funding. In this environment, workforce planning will be important to ensure internal capability continues to meet critical service delivery needs. Sectoral employment actual and forecast Industry: 2008-12 (Recession) 2012-14 (Recovery) 2014 18 (Forecast) Agriculture 800 800 1,300 Mining and quarrying 0-500 0 Manufacturing -11,000 5,500 3,300 Utilities -300-300 0 Water supply & waste 500-500 100 Construction -25,800 2,500 1,800 Retail 13,300-2,500 1,500 Transportation -800 0 800 Accommodation -1,000 800 1,800 ICT -1,000 800 2,300 Financial activities -1,500-1,300-400 Real estate 0 300 500 Professional & scientific 0 800 3,600 Administration services -3,500 2,800 2,200 Public Admin -5,000 1,300-8,300 Education -1,800 3,800-1,100 Health 3,500 8,300 1000 Arts and entertainment 0 2,500 1,200 Other services -300 2,300 900 Total -60,300 27,400 12,400 Headline sectoral GVA forecasts (% p.a.) 2015 2016 2017 2018 Production 3.7% 2.7% 2.5% 2.4% Construction 1.9% 0.9% 1.1% 1.8% Public sector services -0.4% -1.2% -1.2% -1.1% Private sector services 2.5% 2.0% 1.8% 2.2% Total 1.9% 1.1% 1.0% 1.3%
Outlining the research agenda The UUEPC research agenda is focused on the strategic economic priorities of the Northern Ireland economy and in consultation with our sponsors, the Centre is taking forward the following projects: UUEPC Macro-economic model the team are continuing to develop this macro-economic forecasting model in partnership with the Judge Business School, University of Cambridge. The model will provide the framework and empirical test bed to measure the impact of a wide range of policy options as well as underpinning the economic forecasts presented in this report. Development of a Northern Ireland Skills Barometer in recognition of the challenges currently faced by the local economy and the changing demands being placed on the education system, the UUEPC is working with DEL to develop a skills barometer which will seek to identify the key skills requirements across the Northern Ireland economy. Economic Advisory Group (EAG) Competitiveness Index UUEPC will develop a tailored competitiveness index for Northern Ireland in order to inform Government policy on economic development matters. Cost of Division the UUEPC have been asked to undertake a review of the direct cost associated with the delivery of public services in a divided society. This project fulfils a commitment made in the Stormont House Agreement. New sponsors UUEPC is pleased to have signed a new sponsorship agreement with Belfast City Council. We look forward to having a mutually beneficial research relationship with the Council at this time of significant change across the local government sector. Contact Us Director: Professor Neil Gibson E: n.gibson@ulster.ac.uk T: 028 9036 6561 Associate Director: Richard Johnston E: richard.johnston@ulster.ac.uk T: 028 9036 8041 Associate Director: Gareth Hetherington E: g.hetherington@ulster.ac.uk T: 028 9036 8036 Senior Economist: Mark Magill E: md.magill@ulster.ac.uk T: 028 9036 6245 Senior Economist: Dr Jodie Carson E: j.carson@ulster.ac.uk T: 028 9036 6219 Economist: Jordan Buchanan E: j.buchanan@ulster.ac.uk Economist: Laura Heery E: l.heery@ulster.ac.uk Economist: Maria Murphy E: m.murphy1@ulster.ac.uk New staff UUEPC is delighted to welcome two new members of staff to our team. Maria Murphy has joined us from OCO Global, an international economics consultancy and Jordan Buchanan has re-joined the Centre following his graduation. They will both be working as Assistant Economists across a range of research projects. E: economicpolicycentre@ulster.ac.uk W: business.ulster.ac.uk/epc/ T: 028 9036 6561 About UUEPC UUEPC is an independent economic research centre focused on producing evidence based research to inform policy development and implementation. It engages with all organisations that have an interest in enhancing the Northern Ireland economy. The Centre s work is relevant to Government, business and the wider public with the aim of engaging those who may previously have been disengaged from economic debate.