Autumn Statement: Can the UK pull off the confidence trick?

The OBR forecasts improved economic growth…

The Office for Budget Responsibility’s has updated its forecasts for the UK economy and now predicts much faster growth  than it expected in March. The new estimates are for growth in GDP of 1.4% in 2013 and 2.4% in 2014, increases of 0.8% and 0.6% respectively.

…so far so good…

The forecast confirms that the economic strategy launched in the March Budget is working as planned. The support for house purchases and the tax giveaways announced in March have had the desired effect: house prices are rising and consumer confidence has boomed. Workers are more confident about their future employment prospects and have begun to dip into their savings to fund expenditure.

This feel good factor has filtered through to business sentiment, and business confidence has soared. The EY Capital Confidence Barometer recently found that 78% of Uk businesses were confident about the UK economic outlook, up from 22% a year ago.

…time for business to step up?

For the confidence trick to work the economy now requires businesses to begin investing. The OBR assumes  a gradual pick up in 2014 with a 5.1% rise in business investment, supplemented by a 7% increase in public investment, and then an acceleration of growth in business investment to over 8% per annum from 2015 to 2018.

If this business investment materialises then we can expect effective demand to grow and this should increase the demand for labour and  lead to higher earnings,  allowing consumers to spend more, pay their mortgages and  service their debts. This will create a virtuous circle and provide the basis for a sustained period of expansion.

However, the surge in confidence in 2013 has not translated into increased investment. Quite the opposite: business investment is forecast to fall by 5.5% this year by the OBR. All of the renewed optimism in surveys has yet to translate into activity and it appears that the relationship between confidence and investment.

Its touch and go at best…

This is a finely balanced situation. While the increased confidence and upgraded forecasts may provide business with more comfort, there are  a number of factors in the Autumn Statement that will cause them to pause for thought.

  • Strength of the recovery: The OBR’s revisions  include  a slight downgrade in the forecast GDP for 2015 to 2.2% before  a recovery to 2.6 % in 2016 and 2.7% in 2017 and 2018. Business may see this as a signal to defer expenditure a little bit longer to see how things develop.
  • Over-reliance on consumers:The OBR cites slower productivity and earnings growth as reasons why consumer spending is expected to slow in 2014. looking further out, the projections lead to consumer debt of £2.2 Trillion by 2019, equivalent to 162% of income, only 3% off the 165% at the time of the financial crash. This is a leveraged recovery and one very exposed to interest rates and external shocks.
  • Challenging trade conditions: The OBR does not expect much improvement in the UK’s trade performance, with trade contributing very little to GDP growth over the forecast period. The reason given is that the UK’s main export markets are not expected to grow as fast as the overall world economy and it appears the OBR does not expect the UK to be able to accelerate a switch to new markets.
  • Government spending to continue to fall:The reductions in Government spending will continue throughout the forecast removing the potential for increased spending to smooth blips in the recovery.

…and business may continue to wait and see

To  businesses still adjusting to life after the financial crisis, the OBR forecast may will reinforce the current wait and see approach that has led to falling business investment in 2013. As our Capital Confidence Barometer identified, there is a confidence paradox. Businesses are talking about growth but are not committing resources. Plans are very conservative, prioritising lower risk organic activity with a focus on incremental improvement of core products in existing markets. M&A volumes have slumped and the plans that exist for deals envisage small, bolt on acquisitions rather than transformational, mega-deals.

The risk is that business sits and waits dusting off its plans but waiting either for stronger signals on the economy or for competitor moves. We are in a new paradigm, the past is not a reliable guide to the future and having worked hard to survive over the last few years businesses are reluctant to risk another crisis. This recovery could go either way.

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