BCC UK Economic Forecast Q1 2016

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1 BCC UK Economic Forecast Q David Kern, Chief Economist at the BCC The main purpose of the BCC Economic Forecast is to articulate a BCC view on economic topics that are relevant to our members, and to contribute to the wider public debate on policy issues. The Forecast also aims to complement the messages conveyed by the BCC s Quarterly Economic Survey (QES). Main messages The BCC is reducing its UK GDP growth forecasts: to 2.2% for 2016 and to 2.3% for In Q4 2015, we predicted GDP growth of 2.5% for 2016 and to 2.5% for For 2018, included for the first time in our forecast, we are predicting GDP growth of 2.4%. The downgrading of our forecast is due to weaker than previously expected growth across all areas of the economy: manufacturing, services, net exports & household consumption. Lower than predicted actual growth in Q4 2015, and downward revisions of earlier ONS figures for the first 3 quarters of 2015, also contributed to the downgrading of our forecast. Weaker growth than we predicted in most UK sectors reflects a general global slowdown. This is due to lower productivity, adverse demographic trends and geo-political uncertainties. We are now forecasting a worse net trade position than in Q4. This is mostly due to weaker global growth, but it also reflects inadequate domestic drive towards boosting net exports. Services and consumer spending will remain the key growth drivers of the UK economy, even though our new forecast envisages slower growth in these areas than we predicted in Q4. The UK economy is forecast to expand at a moderate pace in the next 3 years, as household consumption & the service sector increase further their contribution to total GDP. We expect quarterly UK GDP growth, after 0.5% in Q4 2015, to remain at 0.5% in Q Quarterly GDP growth is then forecast to average slightly less than 0.6% per quarter from Q onwards, in line with the economy s long-term growth trend 1

2 While the contribution of business investment will increase gradually, the disappointing performance of net exports will be well below the levels needed to rebalance the economy. We expect the first increase in official interest rates to 0.75% in Q4 2016, one quarter later than we predicted in Q4. Further modest increases in UK rates can then be expected, in small 0.25% steps, with official interest rates reaching 1.50% in Q Given the global uncertainties and the recurring turmoil in the markets, it may be necessary to delay any increase in UK rates until The UK unemployment rate is forecast to fall from 5.1% in Q4 2015, to 4.9% in Q4 2016, 4.8% in Q and 4.7% in Q We are forecasting total unemployment to fall from 1,690,000 in Q4 2015, to 1,638,000 in Q4 2016, 1,616,000 in Q4 2017, and to 1,589,000 in Q4 2018, a net overall fall in the jobless total of 101,000 over the next 3 years. Our new unemployment forecasts are lower than predicted in Q4, even though our GDP growth forecast has been revised down. This is because unemployment fell more than we predicted in Q4 2015, productivity is likely to recover more slowly than we envisaged, and the labour market is proving more flexible than we previously expected, making possible bigger falls in the jobless rate before inflationary pressures start building up. Productivity has been weak since the financial crisis. The modest productivity improvement expected in the next few years is disappointing, even though it makes possible bigger falls in unemployment. Strengthening UK productivity growth is a major UK medium-term challenge. Public sector net borrowing is forecast to fall steadily over the next few years. But the official timetable for moving into budgetary surplus in 2019/20 is slightly too ambitious. Our view is that the UK will return to balance in 2019/20, but a move into surplus is only likely in 2020/21. GDP and the main components of demand GDP: UK quarterly GDP growth in Q was 0.5%, after 0.4% growth in Q Year-on-year growth in Q was 1.9%, a steady deceleration from a 3.0% post-crisis peak in Q Full-year UK GDP growth in 2015 was 2.2%, down from 2.9% in However, only three months ago the ONS figures indicated growth of 2.4% for last year. In Q4 2015, UK GDP was 6.7% higher than the pre-downturn peak of Q We expect quarterly UK GDP growth to remain at 0.5% in Q1 2016, and then average slightly less than 0.6% per quarter from Q onwards, in line with the long- term growth trend. Growth in the next 2-3 years will benefit from higher disposable incomes, which will result from rising earnings, low inflation and a strong labour market. 2

3 However, worsening international and domestic uncertainties, and persistent imbalances in the structure of UK growth, will be dampening factors, and pose serious potential risks. In calendar-year terms, GDP growth is forecast to stay at 2.2% in 2016, the same rate as in 2015, and then edge up slowly, to 2.3% in 2017 and 2.4% in Household consumption, though slowing, is forecast to grow at a faster rate than total GDP in 2016 & Annual average growth in household consumption is forecast to slow from 3.0% in 2015, to 2.7% in 2016, 2.5% in 2017 and 2.4% in The UK twin deficits, on current account and budget, remain excessive, and household debt levels are still unduly high. The UK will have to save more in the medium term. Household consumption cannot rely indefinitely on high debt levels and a low savings ratio. Securing stronger productivity increases is a crucial requirement for making possible higher growth in real earnings, and for ensuring that the recovery does not fizzle out. Business investment: In calendar-year terms, we are now predicting growth in UK business investment of 4.5% in 2016, 7.4% in 2017, and 7.4% in Table 1 summarises our forecasts for UK GDP and its main components. Table 1: UK GDP & Main Demand Components, % Change Year on Year GDP 2.2% 2.9% 2.2% 2.2% 2.3% 2.4% Household Consumption 1.9% 2.6% 3.0% 2.7% 2.5% 2.4% General Government 0.5% 2.5% 1.7% 1.8% 1.4% 1.4% Investment 3.2% 7.3% 4.2% 4.1% 6.1% 6.1% of which: Business Investment 2.3% 4.7% 4.7% 4.5% 7.4% 7.4% Exports 1.2% 1.2% 5.0% 2.3% 3.0% 3.0% Imports 2.8% 2.4% 6.2% 3.4% 2.8% 2.8% The external position: net trade & the current account Recent trade figures have been disappointing and the trade balance worsened in Q4 2015, in both real and nominal terms. But the relationship between the ONS real and nominal trade figures is puzzling, and raises questions about the accuracy of the real trade figures. Our new forecast signals a worse net trade position than we predicted in Q4. In both nominal and real terms, the UK trade deficit as a % of GDP is forecast to worsen further in 2016 and then narrow only marginally in 2017 and The UK trade deficit is still too large, and addressing this issue is a national priority. This is particularly important at a time when our current account deficit (which in addition to trade includes items such as investment income and transfers) has worsened markedly between 2011 and 2014, and is still unacceptably large even after improving in The real net trade deficit, having risen to 3.3% of GDP in 2015, is forecast to rise further to 3.7% of GDP in 2016; it will then edge down marginally, to 3.6% of GDP in both 2017 &

4 In full-year terms, growth in real exports accelerated to 5.0% in 2015, while real imports accelerated to 6.2% last year. These figures are puzzling given the weakness in world trade. However, real exports fell in Q3 & Q Our new forecast is that real exports growth, in full-year terms, will be 2.3% in 2016, 3.0% in 2017, and 3.0% in The trade deficit in current prices is forecast to rise from 1.9% of GDP in 2015 to 2.2% of GDP in 2016; it will then edge down slightly, to 2.1% of GDP in 2017 & 2.0% of GDP in The worsening in the UK current account deficit up to, and including in, 2014, was mostly accounted for by the sharp deterioration in the primary income balance. This was mainly due to adverse FDI flows, as income paid on foreign investment in the UK exceeded receipts on UK investments abroad. However, there are signs that net investment income flows have improved in Our forecast is that the current account deficit will improve gradually, from 5.1% of GDP in 2014 to 3.3% of GDP in 2018, still an excessive level. Financing the current account deficit will be manageable in the short term; but failure to achieve a major improvement will make the UK vulnerable to speculative attacks in the medium term and our credit rating could be at risk. Table 2 shows our forecasts for UK net trade, and for the current account balance. Table 2: Balance of Payments: Current Account & Net Trade in Goods & Services NetTrade-Real-Goods&Services-%GDP -2.5% -2.8% -3.3% -3.7% -3.6% -3.6% NetTrade-Real-Goods&Services- bn NetTrade-CrrntPrcs-Good&Serv-%GDP -2.0% -1.9% -1.9% -2.2% -2.1% -2.0% NetTrade-CrrentPrics-Good&Serv- bn NetTrade-CurrentPrices-Goods-%GDP -6.6% -6.8% -6.7% -6.8% -6.9% -6.9% NetTrade-CrrentPrices-Services-%GDP 4.7% 4.9% 4.8% 4.7% 4.8% 5.0% BofP-CurrentAccount-%GDP -4.5% -5.1% -4.3% -4.0% -3.6% -3.3% BofP-CurrentAccount- bn Monetary policy: interest rates, forward guidance & QE Our central forecast is that the first increase in official interest rates, to 0.75%, will occur in Q4 2016, one quarter later than we previously predicted. Further modest increases in official interest rates can then be expected, in small 0.25% steps, with official interest rates reaching 1.50% in Q We believe that mounting international and domestic uncertainties may persuade the MPC to delay any rise in official rates until the first or second quarter of The MPC has stressed that when interest rates start rising, increases will be gradual and moderate, and rates will stay below their historical average levels for the foreseeable future. 4

5 Our forecast envisages that the QE programme would be maintained at its current level of 375 billion. No reduction in the stock of assets held by the BoE is likely to be considered until end But we also predict that there would be no further increases in QE. UK main sectors: manufacturing, services & construction The service sector is by far the largest in the UK economy, accounting for 78.6% of total output; the sector will remain the biggest contributor to GDP growth in the next 3 years. Service sector output is forecast to grow by 2.6% in 2016, 2.7% in 2017 and 2.7% in Manufacturing sector is expected to grow more slowly, by 0.5% in 2016, 1.4% in 2017 and 1.4% in For total industrial output, we are forecasting calendar year growth of 0.5% in 2016, 1.0% in 2017 and 1.0% in The construction figures are very volatile, with large quarterly fluctuations. We are forecasting full-year construction output growth of 0.5% in 2016, 2.6% in 2016 & 2.6% in The share of services in UK output is likely to rise further in the next few years. This shift towards growing reliance on services reflects a long-term change in the economy s structure. Manufacturing is still a significant UK sector, but its share of total output has fallen in recent decades, and now accounts for only 10.3% of the economy. Our forecast indicates that the share of manufacturing in total UK output may shrink a little further in the next few years. Manufacturing is now a well-managed sector, and many firms have retained their skill base during the recession. The sector should benefit from recent falls in the sterling exchange rate. But manufacturing will be hampered in the next few years by worsening global prospects. Table 3 summarises our forecasts for manufacturing, services, and construction. Table 3: Manufacturing, Services & Construction Output, % Change Year-on-Year Manufacturing Output -1.1% 2.7% -0.2% 0.5% 1.4% 1.4% Total Industrial Production -0.8% 1.3% 1.0% 0.5% 1.0% 1.0% Construction Output 1.6% 7.5% 3.4% 0.5% 2.6% 2.6% Services Output 2.8% 3.3% 2.5% 2.6% 2.7% 2.7% Unemployment and the labour market The dynamic and robust UK labour market remains a source of strength for our economy. However, youth unemployment, long-term joblessness, and inactivity are all still too high. The UK unemployment rate is forecast to fall from 5.1% in Q4 2015, to 4.9% in Q4 2016, 4.8% in Q and 4.7% in Q We are forecasting total unemployment to fall from 1,690,000 in Q4 2015, to 1,638,000 in Q4 2016, 1,616,000 in Q4 2017, and to 1,589,000 in Q4 2018, a net overall fall in the jobless total of 101,000 over the next 3 years. 5

6 Our new unemployment forecasts are lower than predicted in Q4, even though our GDP growth forecast has been revised down. This is because unemployment fell more than we predicted in Q4 2015, productivity is likely to recover more slowly than we envisaged, and the labour market is proving more flexible than we previously expected, making possible bigger falls in the jobless rate before inflationary pressures start building up. Productivity has been weak since the financial crisis. The modest improvement expected in the next few years is disappointing, although it makes possible bigger falls in unemployment. Strengthening UK productivity growth is a major UK medium-term challenge. Table 4 summarises our forecasts for total UK unemployment and for youth unemployment. Table 4: UK labour market: total unemployment, youth unemployment and productivity Actual Forecast Q4 14 Q3 15 Q4 15 Q4 16 Q4 17 Q4 18 Unemployment rate, % 5.7% 5.3% 5.1% 4.9% 4.8% 4.7% Unemployed, 000s Youth Unemployment rate, % 16.2% 14.2% 13.6% 13.0% 12.6% 12.1% Youth Unemployed, 000s Output per hour, 2012= Output per hour, YonY % change 0.0% 1.3% 0.3% 1.3% 1.5% 1.7% Youth unemployment: With total UK unemployment forecast to fall to 1,589,000 in Q (a jobless rate of 4.7%), we are forecasting that total youth unemployment (people aged 16 to 24) is expected to fall from 622,000 (a jobless rate of 13.6%) in Q4 2015, to 564,000 (a jobless rate of 12.1%) in Q4 2018, a net fall of 58,000. In line with international definitions, the youth unemployment figure includes people in fulltime education who were looking for part-time work. Inflation and labour costs Annual CPI inflation is forecast to edge up slowly from Q onwards, but is likely to remain below the 2% target until the final months of In annual average terms, we are forecasting annual CPI inflation at 0.9% in 2016, 1.8% in 2017 and 2.2% in In Q4 we predicted 1.1% in 2016 and 2.0% in Table 5 summarises our specific forecasts for CPI inflation. Table 5: UK Annual Inflation, % Change Year on Year CPI 2.6% 1.5% 0.0% 0.9% 1.8% 2.2% 6

7 Earnings growth has slowed markedly in recent months; however, pay is still rising at a rate well above inflation, both including and excluding bonuses. Pay increases in the private sector remain considerably higher than in the public sector. Our forecast is that earnings growth will edge up slowly in the next few years, in line with modest increases in productivity. We are now predicting that total earnings growth (total pay including bonuses) will average 2.6% in 2016, 3.5% in 2017 and 4.0% in The new forecasts for earnings growth are lower than those we made in Q4. UK public finances Public sector net borrowing is forecast to fall steadily over the next few years. But the official timetable for moving into budgetary surplus in 2019/20, outlined in the November 2015 Autumn Statement, is slightly too ambitious. The UK is likely to return to balance in 2019/20, but a move into surplus is only likely in 2020/21. The economy s capacity to generate tax receipts has been damaged since the financial crisis, and we have to adjust to this reality by making long-term cuts in current spending plans. Table 6 compares the BCC s PSNB forecasts, with the OBR s March 2014 forecasts. Table 6: Public Sector Net Borrowing (PSNB) BCC vs. OBR Forecasts PSNBex-BCC forecast-finyears-%gdp 5.2% 4.2% 2.9% 1.6% 0.7% 0.0% PSNBex-BCC forecast-fineyears- bn PSNBex-OBR forecast-finyears-%gdp 5.2% 3.9% 2.5% 1.2% 0.2% -0.5% PSNBex-OBR forecast-finyears- bn Note: Figures show PSNB-ex, i.e. PSNB excluding public sector banks. Negative PSNB indicates surplus. The OBR forecasts were produced for the November 2015 Autumn Statement. Policy issues Though we have downgraded our growth forecast, UK GDP will continue to expand at a stronger pace than in most other G7 economies and broadly in line with our long term trend. Growth will benefit from higher disposable incomes, low inflation and a strong labour market Weaker growth than previously expected in most UK sectors reflects a general global slowdown, which is mainly due to lower productivity, adverse demographic trends & geopolitical uncertainties. Global headwinds are manifested in slowdown in China, falling commodity prices, belowtarget inflation, very low interest rates, and heightened financial markets turmoil. Services and consumer spending will remain the key growth drivers of the UK economy, even though our new forecast envisages slower growth in these areas than we predicted in Q4. 7

8 The UK economy is forecast to expand at a moderate pace in the next 3 years, as household consumption and the service sector increase further their contribution to total GDP. While the contribution of business investment will also increase gradually, the disappointing performance of net exports will be well below the levels needed to rebalance the economy. Our new forecast signals a worse net trade position than we predicted in Q4. In the next few years, we expect little net change in the UK trade deficit as a % of GDP. This is mostly due to weaker global growth, but it also reflects weaker domestic momentum towards boosting net exports than we previously expected. Given the unacceptable size of the current account deficit, failure to achieve a meaningful improvement in net exports will make the UK vulnerable to speculative attacks, and our credit rating could be at risk in the medium term Over the next few years, the main dangers facing the UK economy will arise from worsening global trends. While we cannot control international events, every effort must be made to sustain the areas of domestic strength that underpin and avoid unnecessary risks. We expect the first increase in official interest rates to 0.75% in Q4 2016, one quarter later than we predicted in Q4. Further modest increases in UK rates can then be expected, in small 0.25% steps, with official interest rates reaching 1.50% in Q Given the global uncertainties, and the recurring turmoil in the markets, it may be necessary to delay any increase in UK rates until On its part, the Government must focus on policies that would support higher productivity and a recovery in exports, while persevering with the difficult job cutting the fiscal deficit, mainly by reducing further current public spending as a proportion of GDP. Contact details: David Kern, Chief Economist at the BCC, david.kern@btinternet.com 8