All change in the UK

If a week is a long time in politics…

If a week is a long time in politics, three months feels like a lifetime in economic policy terms. Since the EY ITEM Club spring forecast in April, we have seen the Conservative Party lose its majority in the House of Commons, the negotiations around Article 50 commence, the Bank of England Monetary Policy Committee members hinting at earlier rate rises than previously assumed and questioning of austerity emerging from across the political spectrum.

…leading to a shift in the outlook…

These changes are reflected in the EY ITEM Club summer forecast with revisions to the headline forecasts for GDP for each year. While the outlook for 2017 has been downgraded from growth of 1.8% to 1.5%, 2018 is expected to be slightly better than was forecast in April. However, the real changes are in the medium term as the prospect of a softer Brexit than the EY ITEM Club previously assumed, leads to an upward revision in growth for 2020 and 2021.

Beneath the headline figures, the outlook for consumer spending and business investment remains challenging as confidence appears to have weakened since the spring and this is expected to lead to lower growth in both areas. Trade is expected to provide support to growth even though the pound is now forecast to strengthen relative to the spring forecast, but overall it is clear that the outlook appears to be very challenging.

…with Brexit…

As the EY ITEM Club notes, the outlook for Brexit appears less certain since the election and the start of the Article 50 negotiations. The EY ITEM Club are assuming that the election result makes a transition arrangement more likely, during which the UK’s relationship with the EU continues much as it does at present. At least the new electoral timetable allows time for that. The latest forecast is based on the assumption of a transition arrangement which leads to the stronger forecast for 2020 and 2021. This is a significant change from the spring forecast which assumed the UK would move to a WTO regime in 2019. However, there is clearly significant scope for a range of outcomes.

…and fiscal policy the major uncertainties…

The election also revealed that the public is becoming very weary of austerity, ready to listen to almost anyone who says that enough is enough. The Prime Minister’s former chief of staff and his replacement both agree that this has been a major factor in Labour’s surging popularity. The EY ITEM Club now believes that attempts to curb the growth of spending will need to be handled very deftly in future. Nevertheless the outlook is very uncertain as there is no sign of the Chancellor changing tack. Philip Hammond’s Mansion House speech stuck to the familiar line that higher borrowing to finance current spending would be “asking the next generation to pay”. However, the EY ITEM Club wonder if the Chancellor’s emphasis on current spending leaves open the possibility that he may borrow more for investment in the autumn Budget.

…but the short-term remains challenging…

Despite the changes discussed above, and the potential for support for growth from a softer Brexit and reduced austerity, the message for businesses remains similar to the last forecast – the UK economy is slowing with the consumer sector most exposed and businesses must ensure their plans are realistic in this environment. Beyond the slowdown in the consumer sector, other challenges could include:

  • Changes to the UK labour market as the uncertainty over the post-Brexit arrangements for freedom of movement potentially reduces immigration and creates skill shortages. I have come across a significant amount of anecdotal evidence that this is already an issue.
  • Uncertainty over the level and rate of change in interest rates, businesses need to be sure their financing is in place and that they are able to cope with a faster rate rise scenario;
  • Exchange rate uncertainty. The prospect of a softer Brexit has provided some support to sterling but there could be bumps in the road ahead as the Article 50 negotiations develop.

…and the future cannot be ignored…

There is a difficult balancing act to try and pull off between managing through the short-term while creating the basis to grow if the medium-term outlook does improve as forecast. Business investment has been weak in recent quarters and productivity continues to disappoint. Businesses that want to capture the benefits of improving export markets and a more competitive pound need to invest ahead of the recovery in the economy after 2018. This requires careful and detailed analysis of the likely scenarios and the options for investing in a sensible and managed way.

Download the EY ITEM Club Summer forecast

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