UK consumers are still continuing to spend despite future uncertainty about the economy
The UK economy is performing unexpectedly well, causing us to lift our growth forecast for 2017 from 1.2 per cent to 1.9 per cent and to increase our 2018 prediction from 1.3 per cent to 1.4 per cent.
But unlike the Bank of England, we attribute little of this revision to fiscal stimulus. We see little in the Chancellor of the Exchequer’s Autumn Statement last November or this year’s March budget that will meaningfully boost growth. Instead, we credit an improving global climate, which is particularly benefiting UK manufacturers, and the strong momentum in private consumption, both before and after the Brexit referendum.
So far, UK consumers appear not to have factored future uncertainty into their spending and investment decisions.
Export growth should be strong this year, helped by weaker sterling – which is why the biggest revision in our forecasts concerns exports
Britain’s labour market is also stronger than expected. We have thus revised down our unemployment forecasts slightly, from 5.6 per cent on average in 2018 to 5.5 per cent.
However, our views on the currency, inflation and real wages are unchanged, making this a very challenging year for the UK: we are not revising away our view that the referendum result will have a significant impact on the British economy.
Export growth should be strong this year, helped by weaker sterling – which is why the biggest revision in our forecasts concerns exports. Recent surveys show optimism from manufacturers, but that will not sustain current growth if services – which account for 79 per cent of UK GDP against manufacturing’s 10 per cent – start to slow. And there is already evidence of this.
Just as a pick-up in manufacturing will not outweigh a slowdown in services, a better picture for exports will not make up for weaker consumption. It is consumption that has sustained the UK economy throughout the post-referendum period and consumption, in our view, will now slow it down. Retail sales this year recorded the first quarter-on-quarter fall since 2013 in the three months to January.
To keep consumption growth at current rates would require UK households to further reduce savings from an already low level or increase borrowing at a time of high uncertainty.
And while strong housing markets can boost private consumption – via the wealth effect or spending on new homes – the current property market is softening. Activity levels are likely to be lower in an environment of slowing consumption, despite cheap mortgage rates.
And although business sentiment has improved since the immediate shock of the referendum result, surveys still point to much scaled back investment plans. A potential consumer slowdown and higher input costs as well as uncertainty about access to the EU market and labour supply hardly encourage firms to ramp up investment.
So what happens to inflation? Like the Bank of England, we are leaving our inflation forecasts unchanged, despite the changes to growth. Higher inflation over the next couple of years will reflect the exchange rate and oil price – not price pressures from domestic demand. We see annual inflation reaching 3.7 per cent by December, then falling quickly to end 2018 at 1.8 per cent.
We thus retain our view that the Bank of England will keep interest rates on hold, with no changes to quantitative easing, until at least the end of 2019.
This research was first published on 24 February 2017.