The UK economy is gaining momentum…but is it the right type of growth?
According to the EYITEM Club Autumn UK forecast, while the UK economy has not yet reached Mark Carney’s “escape velocity”, it is accelerating and could grow by 2.4% in 2014. However, with worrying echoes of previous recoveries and subsequent busts, the EYITEM Club does note that this is a consumer and housing led recovery that requires support from exports and business investment in the near term to make it sustainable.
Having waited so long for recovery, what should businesses do now? Is it the time to dust off those investment and M&A plans and move aggressively or is it best to wait just a little bit longer?
At a tipping point
After several years of difficult conditions, the combination of improving bank finances, the Funding for Lending Scheme and the recent Help to Buy initiatives have restored consumer confidence in the UK. Boosted by increasing house prices and firmer employment prospects, households felt confident enough over the summer to borrow to spend. This sparked a 1.5% growth in consumption in the second quarter despite a 0.7% fall in real disposable incomes. The return of consumer confidence is welcome but consumer finances and prospects are not sufficiently strong to support a recovery on their own. For a sustained upturn, increased business investment and export success is required in short order to create the level of activity that will allow real incomes to grow and employment to increase thus supporting increased consumer spending and higher house prices.
All of the surveys of business activity, confidence and expectations are consistent with business starting to move…but we are still waiting for action from business. Indeed, business investment fell by 2.7% in the last quarter and is 8.5% down on the year to date. It is unsurprising after the slowest recovery from a recession for generations that business is cautious. But after the collapse in investment and M&A in recent years and an increasing reliance on temporary and part-time staff, business will need to move quickly to avoid capacity shortages and to be in a position to drive export growth and economic activity.
Using the key indicators
Decisions made by businesses in the coming months will determine how strong and sustainable the UK’s economic recovery will be. These will not be easy choices, so what data should business be using to inform their decisions on when to move?
Without doubt, we can expect to see improved performance from companies linked to the housing sector such as estate agents, law firms, building products companies and home improvement retailers. This is inevitable given the nature of the recovery but this will just serve to confirm what we already know .The more important indicators will include:
- Export performance: are UK companies succeeding in overseas markets? Positive signs will include UK companies making gains in markets in which recent UK performance has been relatively unsuccessful such as China, Indonesia and growth in stronger growing markets such as the USA and Canada. The broader the success the better. If we see growth from Eurozone markets then we can be very confident the export sector is back to rude health.
- Investment: In parallel with performance in export markets, the volume of fixed investment by UK companies will be another critical guide to the strength of the economic recovery. If we see investment increase then we can be much more confident that the UK is creating the productive capacity to exploit an improving economic outlook.
- Labour markets: Employment has grown much faster than output in the UK since the financial crisis leading to a significant fall in productivity. The EYITEM Club expects the initial upturn in growth be achieved by a less than corresponding increase in employment, thus eliminating some of the productivity loss. Acceleration in the rate of hiring will indicate that the economy is moving forward and confidence in the future is increasing. Signs of increased wages need to be carefully tracked and analysed. At one level, increasing wages are a positive sign showing demand increasing in the economy. However, this effect could also indicate capacity shortages or skills gaps that could hamper performance. Deeper analysis will be required to understand the true picture.
- Financial markets: Any increases in lending especially to small and medium-sized businesses will also be indicators of a strengthening recovery.
Recovery is coming closer but the world will remain challenging and even the forecast growth rates of 2.5% or slightly higher in the UK after 2015 are less than the typical rate of acceleration after a recession. After several years of underinvestment and faced with a more competitive world, businesses must now move to assess their business models to ensure they are appropriate for the future environment. In particular, 3 areas require attention:
- Operating model: Is the business optimised for future demand. Is the workforce at the right level and is the business able to remain competitive when faced with wage inflation and a talent war for key skills?
- Capacity: How much investment is required to develop the appropriate productive capacity?
- Financing: Interest rates are starting to edge upwards, is the financing structure future proofed?
The outlook is improving but paradoxically decision-making is becoming harder for businesses. Doing nothing has worked well for the last few years but now, getting the timing, direction and volume of activity correct will be critical both for individual businesses and the economy as a whole.