Economists have been the subject of criticism in recent months …
Following the vote to leave the EU, the UK economy has performed better than some economists predicted. Not all forecasters envisaged a sharp post-referendum slowdown, nevertheless the difference between the outturn and what is perceived as having been the consensus economic forecast has been used by some commentators as evidence of failure of economic forecasting. If this mood persists, it risks creating a mistrust of economic forecasts in general.
Trust in economic forecasts may not improve in 2017. The impact of Brexit is just one of several factors making forecasting extremely challenging. While it is true that we know the outcome of the US presidential election, we are still waiting to understand the details of policy. In Europe, political uncertainty dominates the outlook with elections in major economies upcoming in 2017. These are just two of a range of variables that taken together point to a large degree of uncertainty surrounding the short to medium-term outlook and hence a greater risk of forecast error than normal.
…but writing off economic forecasts risks complacency…
The economy has not fallen off a cliff since the vote on June 23rd: consumers have continued spending and increasing their indebtedness; and businesses appear to have made very few significant changes in strategy as a result of the vote to leave the EU. Many commentators are suggesting that this shows that fears about the UK leaving the EU were over-stated.
However, we are at the start of the Brexit process and the reality is that it is too early to know what the impact of Brexit will be – the detail of the UK’s negotiating position remains unclear and the EU response to any UK proposals even more so. There is a real danger that the current attitude to economic forecasts means that significant changes to the economic outlook will be ignored and risks not properly mitigated. Businesses and consumers need to avoid being lulled into a false sense of security about their future prospects.
…because the UK economy is slowing and changing…
As the EY ITEM Club Winter forecast demonstrates, there are already signs of significant change in the UK economy that will have consequences for businesses and their customers. As the UK moves towards Brexit in 2019, the key features of the UK economy for the next two years will include:
- A lower pound. The pound has fallen by around 15% on a trade weighted basis since January 2016 and the EY ITEM Club expects it to stay at these levels;
- Rising inflation. CPI has already reached 1.6% and is forecast to touch 3% in 2017, averaging 2.8% for the year overall, a major shift compared to recent levels;
- Lower consumer spending growth. Consumer spending is expected to have grown at 2.8% in 2016 but will slow as household incomes are squeezed over the next two years, falling to 1.7% in 2017 and 0.4% in 2018;
- Falling business investment. EY ITEM Club expects business investment to fall in both 2017 and 2018 as overall growth slows, corporate confidence weakens and uncertainty remains high;
- Improving external conditions. World markets are improving and the lower pound will provide some support to UK exporters leading to growth of 3.3% in exports in 2017 and 5.2% in 2018.
In overall terms, the EY ITEM Club expects UK GDP growth to slow to 1.3% in 2017 and 1% in 2018. While there is uncertainty around the exact estimates, the broad direction of travel seems clear: slowing domestic demand not fully compensated for by stronger external demand and hence a shift in the balance of economic activity.
…even before Brexit.
Forecasting the likely outcome of the Brexit negotiations is extremely difficult given the lack of specific information in the public domain. The EY ITEM Club have assumed that the most likely outcome is for the UK’s future trade with the EU to be governed, at least initially by WTO rules. This is only one of the possible scenarios and is not the Government’s preferred outcome, but it remains a possible one given the risk that the ambitious objectives set out by Theresa May cannot be realised within two years. In this scenario, UK GDP growth continues to be challenged for the rest of the decade after 2018, failing to get back to 2% before 2020.
Brexit is only one of the issues to address.
I have consistently advocated “wait and see” as the sensible corporate response to Brexit, reflecting the absence of detailed information on which to base significant decisions. However, whatever the outcome of the Brexit negotiations, there are clear signs of change in the UK economy which point to a slowdown and shift in demand in the next couple of years, before any formal Brexit.
Now is therefore the time for businesses to review their strategies and associated business plans and to update these to reflect the slowing UK macro-environment. Slowing growth and rising inflation, together with a depreciating currency, could potentially be an unhealthy cocktail. It would not take much for the economy to spiral further downwards at which point starting to act may be too late.
The key short-term steps are:
Review the next two years of the current business plan in the light of the changed UK macro-economic outlook and identify any realignment and risk mitigation activities that are required. Then assess the “knock on” effects for the post-Brexit plan.
Evaluate the scope for changes in any international activities. The pound looks set to stay at current levels for some time and hence both export and import activities need to be re-assessed. The USA could become an increasingly attractive market if President Trump provides the stimulus he has alluded to. Equally, commodity and oil prices appear to be strengthening and this should boost growth in the emerging markets. However, imports will become more expensive and so sourcing and location strategies require review.
For the period beyond two years, Brexit will be the key issue to consider. The exact nature of any settlement remains difficult to call but it is important to be developing options for potential future moves. Certainly stress testing the business against a WTO option after 2019 would be sensible to understand the potential scale of the challenge in what would appear to be a plausible worst case outcome.
Finally, it is important to continue to provide the UK Government with guidance on the priorities for the exit negotiations and future trade priorities.