A difficult forecasting environment…
We all know that economic forecasting is difficult at the best of times but the UK’s path to leaving the European Union (EU) makes predictions even harder than usual. As the latest EY ITEM Club forecast makes clear, the outlook is complex and cannot be simply characterised as a typical economic slowdown: the consequences of Brexit could potentially impact sectors and segments of the UK economy in very different ways.
…which increases the risk of complacency…
The economy has not fallen off a cliff since the vote on June 23rd and commentators have been suggesting that this shows that fears about the UK leaving the EU were over-stated. The reality is that it is too early to celebrate the success of Brexit. Our sense from discussions with the corporate sector is that businesses are waiting for both data that has been collected post-referendum and for the details of future policy that the Autumn Statement is expected to provide. There have been no major moves as yet, the mood has been one of wait and see.
However, employment growth is slowing, wages are not rising as fast as EY ITEM Club previously expected and factory gate inflation is increasing and this will hit consumer prices next year. All of this points to a slowdown in consumer spending in 2017. The EY ITEM Club is forecasting consumer spending growth of 0.5% in 2017, a major change from the growth of 2.5% achieved in 2015. While the EY ITEM Club has been advising of a gradual slowdown in consumer spending for some time, the move towards Brexit has accelerated the expected rate of that slowdown.
At the same time, policy uncertainty has risen to record levels and this is feeding through into lower levels of business confidence which EY ITEM Club expects to translate into lower investment in 2017. This is also consistent with what we are hearing. Policy uncertainty together with a squeeze on margins from input cost inflation and a tightening labour market in some areas is leading to investment projects that are seen as marginal either being cancelled or delayed, with some of this capital being diverted to other geographies.
…but the signs are that there will be a slowdown in 2017 and a slow recovery afterwards…
The slowdown in consumer spending and investment will, EY ITEM Club expects, be compensated for to some extent by higher exports and some degree of stimulus from Government spending but GDP growth in 2017 will be low at around 0.8%. There will be some recovery afterwards but the headwinds on consumers and the reluctance to invest by businesses means that growth will not reach 2% annually by the end of the decade. It seems that the UK is facing a period of relatively low growth by historic standards.
…characterised by uncertainty and variability
Beyond 2017, the outlook will be influenced significantly by the evolution of the UK’s negotiations with the EU on exit and future trading arrangements, assuming the latter are part of the exit process. Details are sparse at this stage but the emphasis that the Government placed on control, especially over the movement of labour, during the Conservative party Conference suggests that the UK will be seeking to negotiate a bespoke deal unlike any other existing EU trade agreement.
It may well be that this may be difficult to achieve and the UK and EU move towards trade on terms more akin to those available under the rules of the World Trade Organisation (WTO).
Certainly the new UK administration appears structured and willing to consider a deal along WTO lines. As the EY ITEM Club analysis shows, sectors such as financial and business services look vulnerable in this scenario as do certain goods sectors, such as aviation. The UK would need to develop a policy on agricultural subsidies and an industrial strategy to mitigate the shift to the new trading model. What is clear is that the impact will vary by sector and the specific impact will be difficult to estimate.
Time to start preparing
I have been an advocate of “wait and see” as far as corporate responses to Brexit are concerned, as there has been little post-referendum data or policy guidance on which to base decisions. While there is still a great deal of uncertainty, it does seem possible based on recent developments, both in the UK and in the policy statements of European politicians, that a “Hard” Brexit, by which I mean based around WTO rules, could happen and is currently probably the most likely case. It may well be that over time, further negotiations improve the situation.
Now is the time for businesses to update their strategies and associated business plans to reflect the slowing macro-environment and emerging policy outlook. Slowing growth and rising inflation together with a depreciating currency could potentially be an unhealthy cocktail. “Hard” Brexit is a downside on the current position but should now be the base case for future decision-making.
The key steps are:
► Start with looking again at potential vulnerabilities in the current plan given recent developments and identify any short-term moves required to mitigate these.
► Review capital allocation and consider investment decisions in the light of the future outlook. It now makes sense to consider investing more in export capacity given the low pound and push for new trade partners, while investing to substitute increasingly high cost imports may start to become more economically advantageous.
► Business structure is another potential area of change. Is there an option to change the business to place some parts in the future EU and others outside? This might also highlight possible M&A requirements either buying or selling of assets.
► Robust analysis of the preceding two areas could provide the UK Government with guidance on the exit negotiations or future trade priorities.
EY ITEM Club is part of the EY Economics for Business programme