UK Economic Forecast Q3 2015

UK Economic Forecast Q3 2015 BUSINESS WITH CONFIDENCE

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Introduction Welcome to the Q3 2015 ICAEW Economic Forecast, based on the views of the people running UK plc; ICAEW Chartered Accountants working in businesses of all types, across every economic sector and in all regions of the UK, surveyed through the quarterly ICAEW/Grant Thornton UK Business Confidence Monitor (BCM). For the first time, this quarter we present forecasts for 2016 as well as 2015. Key findings this quarter. The economy is forecast to grow by 2.6% in both 2015 and 2016. Our 2015 forecast has been revised up from 2.3%, as a post-election bounce in business confidence points to faster economic expansion over the coming months. In addition, rising earnings growth and very low inflation are continuing to boost household spending power. Business investment is expected to grow by 7.4% this year, but a slowdown to 5.9% in 2016 is expected. Declining spare capacity should encourage some businesses to invest, though a weakening global economic outlook will curb investment among other companies. Capital spending in the energy, water & mining sector is expected to fall back as commodity prices remain subdued. We have revised up our unemployment forecast for this year. We now expect the unemployment rate to average 5.4% in 2015, up from a previous forecast of 5.1%. The latest labour market data showed a slight increase in unemployment. Firms appear to be making better use of existing staff, with full-time work on the increase while part-time work declines. This should boost productivity in the economy. Deficit reduction could easily turn into a three parliament problem the Chancellor s July Budget decisions saw him reduce the pace of fiscal austerity compared with the March Budget. Slower growth beyond 2016 could easily leave the UK with a fiscal deficit after the next general election. Despite a turbulent few months for the global economy with clear signs of a notable slowdown in China and Greece s debt crisis rumbling on the UK has continued to fare relatively well. However, there are significant risks over the coming months and years. It s becoming increasingly clear that the world economy has lost momentum. As well as weakness in China, international trade data have been worse than expected. For now, the UK economy is being propped up by business investment and the boost to household spending power from low inflation and rising earnings. But global events could soon start to impact the UK more severely, particularly if further impetus is lost. While our central forecast is for the Bank of England to raise interest rates in early 2016, it may decide to wait longer if the world economy continues to slow. 3

Economic outlook FIG. 1 REAL GDP ANNUAL GROWTH FIG. 2 REAL GDP INDEX (2007 = 100) % 4 3 2 1 0-1 -2-3 -4-5 -6 2.6 2.8 2.6 2.6 1.9 1.6 1.7 0.7-0.3-4.3 2007 2008 2009 2010 2011 2012 2013 2014 2015f 2016f 110 108 106 104 102 100 98 96 94 92 90 106.8 104.1 101.1 100 99.7 98.8 99.4 97.2 95.4 2007 2008 2009 2010 2011 2012 2013 2014 2015f 109.6 2016f Source: ONS, ICAEW forecasts UK GDP is expected to grow by 2.6% in both 2015 and 2016. The global economy presents a significant risk to these forecasts. UK economic growth accelerated in the second quarter of 2015, with GDP expanding at a quarter-on-quarter rate of 0.7%, up from 0.4% in Q1 2015. Household spending, exports and business investment all contributed to growth in the quarter. Overall, the economy looks set to post a solid performance across the year as a whole ICAEW now expects growth of 2.6% this year, up from a previous forecast of 2.3%. The latest BCM Confidence Index shows a sharp improvement in business sentiment following the decisive outcome of the general election which ended months of uncertainty. In addition to improving business confidence, consumers are also generally benefiting from current developments in the labour market. Earnings growth has picked up since 2014 and, at the same time, inflation stands close to zero something which looks set to continue over the coming months as oil and other commodity prices remain subdued. Households are seeing a significant increase in their spending power something which is likely to persist into 2016. Beyond this year, we expect economic growth to remain steady at 2.6% in 2016. However, there are sizeable downside risks to these projections. With the Chinese economy slowing and a flurry of weak international trade data, the world economy seems to be losing momentum. Ultimately this is going to hold back exports and curb business investment in the UK. 4

Business investment FIG. 3 REAL BUSINESS INVESTMENT ANNUAL GROWTH % 15 10 5 0 8.1 3.3-14.4 3.7 6.0 4.2 5.3 8.0 7.4 5.9-5 -10-15 -20 2007 2008 2009 2010 2011 2012 2013 2014 2015f 2016f Source: ONS, ICAEW forecasts Investment forecast for this year revised up as confidence increases and spare capacity declines. However, growth is expected to slow in 2016. With a post-election bounce in business confidence this quarter, we have revised up our 2015 business investment growth forecast from 4.0% to 7.4%. However, we expect business investment growth to slow in 2016 to 5.9%. The slowdown in major parts of the global economy is expected to curb some investment, particularly among the largest, most export-dependent industries. Partially offsetting this will be diminishing slack in the UK economy. BCM shows that there are now more firms operating at, or above, capacity than there are below capacity. water & mining sector. Declining capital spending here is unsurprising given the outlook for commodity prices. Global economic fragility is bearing down on demand for oil and metals and, in turn, prices. At the same time, increasing world oil supply is also curbing prices to the detriment of the UK s oil industry. Iraq s oil production climbed to an all-time high in July and the lifting of international sanctions against Iran will also boost global oil supplies and keep prices low. Ultimately, this means that the UK s energy, water & mining sector is in for a tough time. BCM shows that all major sectors of the economy expect to expand capital spending over the next 12 months, with the exception of the energy, 5

Labour market FIG. 4 AVERAGE EARNINGS ANNUAL GROWTH FIG. 5 UNEMPLOYMENT RATE % 6 5 4 3 2 1 0-1 4.9 2007 3.5 2008-0.2 2009 2.3 2010 2.7 2011 1.3 1.3 1.1 2012 2013 2014 2.6 2.7 2015f 2016f % 8.5 8 7.5 7 6.5 6 5.5 5 4.5 5.3 2007 5.7 2008 7.6 2009 7.9 2010 8.1 8.0 2011 2012 7.6 2013 6.2 2014 5.4 2015f 4.7 2016f Source: ONS, ICAEW forecasts Source: ONS, ICAEW forecasts The labour market has turned a corner. Expect slower job creation, but a more solid rate of earnings growth. The labour market has reached something of a turning point on the latest data. After a period of sustained and significant falls, unemployment has ticked up. In Q2 2015, unemployment rose by 25,000 compared with the previous quarter, but remained 221,000 lower than a year ago. While ICAEW expects unemployment to start declining again later in the year, we have revised up our unemployment rate forecast for 2015 as a whole from 5.1% to 5.4%. We expect the rate to decline to 4.7% in 2016. The latest labour market data suggest that, rather than hiring new staff, companies may be making better use of their existing workforce something which should boost productivity in the economy. Between Q1 2015 and Q2 2015, the number of full-time employees rose by 12,000, while the number of part-time employees declined by 66,000. The share of part-time workers doing so because they could not find a full-time job fell from 16.1% to 15.8%. Although job creation has slowed, earnings growth has picked up since the start of the year. We now expect average employee earnings to grow by 2.6% this year, significantly higher than the annual growth of about 1% seen over the period 2012-2014 and up from our previous forecast of 2.0%. We expect similar wage growth in 2016. The introduction of the National Living Wage, announced in the July Budget, is expected to contribute to the continuation of higher earnings growth in 2016. It will apply to all workers aged 25 and over and start at 7.20 per hour in April 2016. 6

Focus on: Austerity in the new parliament FIG. 6 REAL GOVERNMENT CONSUMPTION ANNUAL % CHANGE 3 2.5 2 1.5 1 0.5 0-0.5-1 -1.5 2014 2015 2016 March 2015 Budget July 2015 Budget 2017 2018 2019 2020 FIG. 7 PUBLIC SECTOR NET BORROWING, BN 180 160 140 120 100 80 60 40 20 0-20 March 2015 Budget July 2015 Budget 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Source: OBR Economic & Fiscal Outlook, March and July 2015 publications. Note that a negative net borrowing figure means the government is running a fiscal surplus The first Conservative Budget in nearly 20 years saw an easing in the pace of austerity. In the first Conservative Government Budget in nearly 20 years, the Chancellor announced a raft of new policies. Many had been mentioned before the July Budget, such as increases in inheritance tax thresholds and personal allowances. But there were some rabbits pulled out of the hat. It was announced that corporation tax will be reduced to just 18% by the end of the current parliament. The Chancellor s announcement of a National Living Wage, left right to the end of his Budget speech, also caught many by surprise. All in all, the policies announced are a mixed bag for businesses. Further reductions in corporation tax will continue the progress made in the last parliament in making the UK one of the most desirable advanced economies in which to do business. But the National Living Wage represents a significant cost increase for some firms, particularly in sectors where low pay is relatively prevalent such as retail, hospitality and care. In addition, other policies such as the removal of Dividend Tax Credit and the levy on large employers to fund apprenticeships will also negatively impact some businesses. The overall economic implications of this Budget are not immediately obvious especially as some probusiness policies have been at least partly offset by policies which are costly to businesses. Households, too, have seen the Chancellor give with one hand and take with another. Many of those benefiting from the National Living Wage, for example, also face significant reductions in the amount of government benefits they will receive. 7

Focus on: Austerity in the new parliament (continued) The fiscal implications of the Budget are more immediately apparent. Compared with the coalition government s March Budget, the Conservative s July Budget actually shows a lower level of austerity over the next five years. Government consumption is now expected to grow in every year of the new parliament, even once adjusted for inflation. In the March Budget, sizeable declines had been announced over the period 2016-19. The Chancellor now does not expect to be running a fiscal surplus, with the government receiving more than it spends, until 2019/20 the very last fiscal year of the new parliament. Previously, the Chancellor expected a surplus in 2018/19. In short the Chancellor has opted for a strategy where there is less of a chance of austerity significantly bearing down on economic growth. He has now left balancing the government s books until right at the very end of the parliament. If growth in the medium term falls short of the OBR s predictions something which seems very likely if the global economy continues to falter deficit reduction will easily shift from being a two parliament problem to a three parliament one. That could lead to some awkward conversations at the next general election. 8

Forecasting methodology Headline economic forecasts 2007 2008 2009 2010 2011 2012 2013 2014 2015f 2016f Real GDP annual growth % +2.6-0.3-4.3 +1.9 +1.6 +0.7 +1.7 +3.0 +2.6 +2.6 Real business investment annual growth % +8.1 +3.3-14.4 +3.7 +6.0 +4.2 +5.3 +8.0 +7.4 +5.9 Labour market forecasts 2007 2008 2009 2010 2011 2012 2013 2014 2015f 2016f Earnings (total pay) annual growth % +4.9 +3.5-0.2 +2.3 +2.7 +1.3 +1.3 +1.1 +2.6 +2.7 Employment annual growth % +0.8 +0.9-1.6 +0.2 +0.5 +1.1 +1.2 +2.3 +1.4 +1.3 Unemployment rate % +5.3 +5.7 +7.6 +7.9 +8.1 +8.0 +7.6 +6.2 +5.4 +4.7 ICAEW s forecasts for economic growth, business investment and the outlook for the labour market are based on the correlation between ICAEW/Grant Thornton Business Confidence Monitor (BCM) indicators and official economic data. BCM contains data from a survey of 1,000 UK businesses on business confidence, financial performance, challenges and expectations. BCM indicators provide a useful and unique steer on future developments in the UK economy. 9

About Cebr Centre for Economics and Business Research is an independent consultancy with a reputation for sound business advice based on thorough and insightful research. Since 1992, Cebr has been at the forefront of business and public interest research. They provide analysis, forecasts and strategic advice to major UK and multinational companies, financial institutions, government departments and agencies and trade bodies. For further information about Cebr please visit www.cebr.com ICAEW is a world leading professional membership organisation that promotes, develops and supports over 144,000 chartered accountants worldwide. We provide qualifications and professional development, share our knowledge, insight and technical expertise, and protect the quality and integrity of the accountancy and finance profession. As leaders in accountancy, finance and business our members have the knowledge, skills and commitment to maintain the highest professional standards and integrity. Together we contribute to the success of individuals, organisations, communities and economies around the world. Because of us, people can do business with confidence. ICAEW is a founder member of Chartered Accountants Worldwide and the Global Accounting Alliance. www.charteredaccountantsworldwide.com www.globalaccountingalliance.com ICAEW Chartered Accountants Hall Moorgate Place London EC2R 6EA UK T +44 (0)20 7920 8705 E economicforecast@icaew.com linkedin.com find ICAEW twitter.com/icaew facebook.com/icaew ICAEW 2015 MKTPLN14268 09/15