UK Economic Forecast Q3 2014

Transcription

1 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). Table of Contents Key messages... 2 GDP and the main components of demand... 3 The external position: net trade & the current account... 5 Monetary policy: interest rates, forward guidance & QE... 7 UK main sectors: manufacturing, services & construction... 8 Unemployment and the labour market Youth unemployment Inflation and labour costs UK public finances Policy issues Contact details BCC UK Economic Forecast Q PAGE 1 OF 14

2 Key messages The BCC is upgrading slightly its short-term UK GDP growth forecasts: to 3.2% for 2014 and to 2.8% for For 2016, our GDP growth forecast remains unchanged, at 2.5%. In Q we predicted GDP growth of 3.1% in 2014, 2.7% in 2015 and 2.5% in The upgrading of our forecasts for 2014 & 2015 is mainly due to the following factors: - A stronger labour market than we predicted in our Q2 forecast. - Stronger growth than we previously predicted in Q3 & Q Upgraded ONS estimates for year-on-year GDP growth in Q The realistic possibility that the ONS would upgrade its back data for the first half of We are forecasting stronger growth in household consumption, investment & services output than we predicted in Q2; and a weaker, but still positive, contribution to growth from net trade. The unemployment rate is forecast to fall from 6.4% in Q2 2014, to 5.5% in Q2 2015, 5.0% in Q and 4.9% in Q2 2017; these are lower jobless rates than we predicted in Q2. We expect the first increase in Bank Rate, to 0.75%, to occur in Q1 2015, an unchanged timetable since our last forecast. But pressures for an earlier rise in rates are intensifying. Further modest increases in official interest rates can then be expected, in small 0.25% steps, with official interest rates reaching 1.25% in Q and 2.25% in Q After official rates start rising early in 2015, household consumption will slow markedly. But consumption will still contribute to GDP growth more than other areas of the economy. Our GDP growth forecasts are satisfactory. But we are predicting a marked slowdown, from 3.2% in 2014 to 2.5% in This reflects a deceleration in household consumption growth, which more than offsets greater contributions to growth from investment and net trade. The greater contribution to growth of net trade is not as large as we predicted in Q2. Falling public spending and stock building as a share of GDP will also reduce GDP growth. In terms of output, the main contributor to UK growth in the next three years will be services. But manufacturing and construction will also record satisfactory positive growth in this period. Productivity will increase modestly in the next few years, but at a pace that is considerably slower than before the financial crisis. Underlying public sector borrowing is forecast to fall over the next three years, but at a slightly slower pace than envisaged in the OBR predictions made in March BCC UK Economic Forecast Q PAGE 2 OF 14

3 GDP and the main components of demand GDP: Quarterly UK growth in Q was 0.8%, as predicted, after growth of 0.8% in Q and 0.7% in Q But annual growth in Q was revised up to 3.2%. As expected, in Q2 2014, UK GDP was 0.2% above the pre-recession peak in Q UK GDP growth in recent quarters was stronger than in most other G7 economies. Year-on-year UK growth in Q was 3.2%, higher than 2.4% in the US and 1.3% in Germany. But longer-term comparisons show that UK GDP in Q was just 0.2% above its pre-crisis peak in Q However, real GDP in Germany and the US have been for some time above their pre-recession levels. Sharp falls in oil & gas output, and financial sector weaknesses, have been major factors contributing to the relative weakness of the UK economy before Table 1 summarises our forecasts for UK GDP and its main components. Table 1: UK GDP & Main Demand Components, % Change Year on Year GDP 1.1% 0.3% 1.7% 3.2% 2.8% 2.5% Household Consumption -0.5% 1.5% 2.2% 2.9% 2.8% 2.2% General Government 0.0% 1.6% 0.7% 0.9% 1.0% 0.8% Investment -2.4% 0.8% -0.8% 7.1% 5.5% 5.7% of which: Business Investment -1.3% 3.9% -1.0% 10.7% 7.4% 7.4% Exports 4.5% 1.7% 0.5% 0.8% 4.1% 4.6% Imports 0.3% 3.4% 0.2% 0.1% 3.7% 4.1% We expect quarterly GDP growth of 0.8% in Q3 & Q4 2014, followed by 0.7% growth in Q1 2015, and a more marked slowdown to 0.6% growth per quarter from Q onwards. As official rates start rising in 2015, indebted households with mortgages will face increased financial pressures, and weaker household consumption will slow markedly GDP growth. In calendar-year terms, GDP growth is forecast to accelerate from 1.7% growth in 2013 to 3.2% in 2014, and then slow markedly to 2.7% in 2015 and 2.5% in Household consumption growth accelerated from -0.5% in 2011 to 1.5% in 2012 and 2.2% in 2013, as lower inflation in the past 2 years has eased the squeeze disposable incomes. Consumption also benefited from the positive wealth effects of rising house prices. We expect calendar-year growth in household consumption to strengthen further, to 2.9% in 2014, and then slow to 2.8% in 2015 and 2.2% in The UK households savings ratio fell to very low levels before the financial crisis, and averaged only 2.1% in 2007 and 2.2% in BCC UK Economic Forecast Q PAGE 3 OF 14

4 Thereafter, the savings ratio rose sharply, to 7.0% in 2009, and fluctuated around this level until 2012 when it averaged 7.3%. In 2013, with consumer spending recovering, the savings ratio fell to an average of 5.2%, still much higher than before the financial crisis. In Q and Q the savings ratio was slightly below 5.0%. Our new forecast envisages further near-term falls in the savings ratio, as robust GDP growth and rising asset prices boost consumer confidence. However, the expected rise in mortgage interest rates from the spring of 2015 will make households more cautious, even if the initial reaction will be to use their savings in order to help finance higher debt service payments. In calendar-year terms, we are forecasting that the savings ratio will fall to 4.0% in 2014 and 3.5% in 2015, before edging back up to 4.0% in The savings ratio will still be higher in the next few years than at its historically lows in 2007 & But, in view of the need to reduce very high levels of household debt and to cut the huge current account deficit, we will have to save more once growth returns to normal. The recent spurt in UK growth was boosted by the impact of the buoyant housing market on household consumption, but this is causing concern. Household consumption cannot rely indefinitely on increased debt and a falling savings ratio. With productivity increases remaining low by historical standards, only modest rises in real earnings will be affordable. Unless stronger productivity growth makes higher increases in real earnings affordable, the recovery would slow further and may even fizzle out. Business investment recorded very sharp falls following the financial crisis. The published figures have been very volatile, and the ONS has made frequent & unusually large revisions. In calendar-year terms, UK business investment fell by 1.0% between 2012 and But recent growth was exceptionally strong. In Q1 2014, business investment recorded a quarterly increase of 5.0%, and it was 10.6% higher than a year earlier. Nevertheless, Q1 business investment was still 15.5% below its Q pre-recession peak. Our new forecast envisages strong positive growth in business investment over the next few years, but from a relatively low base. In calendar-year terms, we expect UK business investment to record growth of 10.7% in 2014, 7.4% in 2015 & 7.4% in Even so, business investment will only surpass its Q peak in Q BCC UK Economic Forecast Q PAGE 4 OF 14

5 The external position: net trade & the current account The UK trade deficit is now markedly smaller than before the financial crisis. In , the goods & services trade deficit averaged 3.5% of GDP in real terms and 2.7% in current prices. In , the deficit averaged 1.3% of GDP in real terms and 1.8% in current prices. A larger surplus in services has made the main contribution to the improvement. The much-needed rebalancing of the UK economy towards net exports is still inadequate, but there has been real progress. In the next few years, we expect the deficit to narrow further. Table 2 shows our forecasts for UK net trade, and for the account current balance. Table 2: Balance of Payments: Current Account & Net Trade in Goods & Services NetTrade-Real-Goods&Services-%GDP -1.0% -1.5% -1.4% -1.1% -1.0% -0.8% NetTrade-Real-Goods&Services- bn NetTrade-CurrntPrics-Goods&Servics-%GDP -1.5% -2.1% -1.8% -1.5% -1.3% -1.2% NetTrade-CurrentPrics-Goods&Servics- bn NetTrade-CurrentPrices-Goods-%GDP -6.5% -7.0% -6.7% -6.6% -6.6% -6.6% NetTrade-CurrentPrices-Services-%GDP 5.0% 4.8% 4.9% 5.1% 5.3% 5.4% BofP-CurrentAccount-%GDP -1.5% -3.8% -4.5% -4.0% -3.5% -3.1% BofP-CurrentAccount- bn Our forecast is that the real net trade deficit will fall from 1.4% of GDP in 2013 to 0.8% in 2016, while the net deficit in current prices will fall from 1.8% of GDP in 2013 to 1.2% in The goods deficit is likely to fall marginally, from 6.7% of GDP in 2013 to 6.6% in 2016, while the trade surplus in services will increase more substantially, from 4.9% of GDP to 5.4%. In contrast to the trade deficit, the UK current account deficit is larger than before the crisis. While the net trade balance improved, the current account deficit worsened sharply in 2013, to 4.5% of GDP, highest since the 4.6% of GDP record current account deficit in In the second half of 2013, the current deficit ballooned to 5.9% of GDP in Q3 & 5.7% in Q4. In Q1 2014, the current account deficit fell to 4.4% of GDP, still a very high level BCC UK Economic Forecast Q PAGE 5 OF 14

6 The main factor accounting for the worsening current deficit in 2013 was the deterioration in the income balance. The UK income balance, though traditionally in surplus, moved into deficit since mid This is mainly due to adverse FDI flows and, possibly, financial sector weaknesses. The income balance deficit widened considerably in recent quarters. Prospects for the current account are very uncertain, because it is unclear whether, and to what extent, the income balance will recover following its very sharp recent worsening. Our forecast is that the current account deficit will shrink from 4.5% of GDP in 2013 to 3.1% of GDP in 2016; this will still be a very high level, which could make the UK potentially vulnerable to speculative attacks, particularly if the income balance fails to improve. Financing the deficit will not be a problem in the short term, but the UK will face serious long-term risks without a more meaningful reduction in the current account deficit BCC UK Economic Forecast Q PAGE 6 OF 14

7 Monetary policy: interest rates, forward guidance & QE Since the unemployment rate has fallen more sharply than originally envisaged, the MPC s forward guidance has relied since February 2014 on a wider range of indicators. But efforts to provide clarity and support the recovery are being hampered by repeated calls for early interest rate rises, and by apparent inconsistencies in the various comments made by Governor Carney and other MPC members. To sustain business confidence, the MPC should strive to communicate clearly and avoid contradictions in its messages. In our view it is too early to start raising official interest rates. The MPC has stressed that when rates start rising, increases will be gradual and moderate. Businesses accept this, but the message must be clearer. Our new central forecast is that the first increase in Bank Rate, to 0.75%, would occur in Q This timetable is unchanged since our Q2 forecast. Further modest increases in official rates can then be expected, in small 0.25% steps, with official rates reaching 1.25% in Q and 2.25% in Q While not raising rates prematurely is important, keeping rates as low as possible over the medium term is more critical for business confidence than the timing of the first increase. Our current interest rate forecast is consistent with continued moderate economic growth. Gradual Bank Rate rises starting in 2015, to reach a level of 2.25% by end-2016, would be preferable to a situation in which the MPC delays unduly the first rate increase, but is then forced to tighten aggressively because it loses credibility as an inflation fighter. The recovery is still fragile, and the rise in sterling since March 2013, which is equivalent to a tightening in monetary policy, is an important reason for not raising rates prematurely. Our forecast also 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 would be considered at least until mid But we also predict that there would be no increases in QE. UK inflation is now below target, but it has been above target for more than 4 years. The MPC must make every effort to sustain the credibility of its commitment to low inflation. The MPC should do more to support a revival in business lending, both by making better use of the existing QE programme, and by using measures other than QE alone. If the MPC agrees to purchase private sector assets other than gilts, such as securitised SME loans, banks would be less risk-averse in lending to businesses. The Funding for Lending Scheme (FLS) has reduced funding costs, and helped the housing market, but has not made the banks less risk averse towards key areas of business lending BCC UK Economic Forecast Q PAGE 7 OF 14

8 UK main sectors: manufacturing, services & construction In Q2 2014, service sector output recorded quarterly growth of 1.0%, and was the UK economy s main growth driver. Total production recorded quarterly growth of 0.3% in Q2, with manufacturing increasing by 0.2%. But construction sector output was flat in Q Year-on-year growth in Q was 3.3% for manufacturing, 2.1% for total production, 4.8% for construction and 3.3% for services. In Q2 2014, service sector output was 3.0% above its pre-recession level in Q However, other sectors were still were below pre-recession levels in Q2 2014: -7.4% for manufacturing, % for total production, and -10.2% for construction. The main contributor to UK GDP growth in the next 3 years will remain the service sector, which is expected to contribute some 80% of total UK GDP growth. But manufacturing and construction will also record satisfactory positive growth in this period. Table 3 summarises our specific forecasts for manufacturing, services, and construction. Table 3: Manufacturing, Services & Construction Output, % Change Year-on-Year Manufacturing Output 1.8% -1.7% -0.8% 3.0% 1.5% 1.6% Total Industrial Production -1.2% -2.4% -0.4% 2.0% 1.4% 1.4% Construction Output 2.3% -8.1% 1.7% 4.3% 2.8% 3.0% Services Output 1.5% 1.3% 1.9% 3.3% 3.1% 2.7% In calendar year terms, manufacturing output fell by 1.7% in 2012 & by 0.8% in But growth was positive in recent quarters. We expect positive growth in the next few years. But the pace of expansion will be weaker than in the service sector. Our forecast envisages positive manufacturing growth of 3.0% in 2014, 1.5% in 2015 & 1.6% in Total industrial output fell by 2.4% in 2012 & by 0.4% in Our new forecast envisages positive calendar year growth of 2.0% in 2014, 1.4% in 2015 & 1.4% in Manufacturing is still a significant sector, but its share of total UK output has fallen in recent decades, and now accounts for only 10.4% 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. In spite of sterling s recent strength, the sector is still benefiting from a relatively competitive exchange rate, due to large sterling falls between 2007 & Manufacturing is now a well-managed sector, and many firms have retained their skill bases during the recession BCC UK Economic Forecast Q PAGE 8 OF 14

9 A challenging global environment and the eurozone s problems will limit manufacturing exports in the next few years. But the prospects for manufacturing are relatively positive. Construction output recorded a calendar year fall of 8.1% in But the sector bounced back in the past year, reflecting the strong housing market upturn, with positive calendar year growth of 1.7% in In Q2 2014, construction output was 4.8% higher than a year earlier. With house building expected to increase, and with infrastructure spending likely to rise, we expect positive quarterly growth in construction output in the next few years. In full-year terms, we predict construction output growth of 4.3% in 2014, 2.8% in 2015 & 3.0% in Quarterly construction figures are very volatile and may cause swings in the annual figures. The service sector is the largest and strongest sector in the UK economy, accounting for 77.8% of total output. In 2013, services output recorded calendar year growth of 1.9%. Service sector output is forecast to record calendar year growth of 3.3% in 2014, 3.1% in 2015, and 2.7% in The share of services in total output is likely to rise a little further in the next few years. This continued steady trend towards increasing reliance on services will reflect structural changes in the UK economy, and is not in itself a cause of concern BCC UK Economic Forecast Q PAGE 9 OF 14

10 Unemployment and the labour market The UK labour market strengthened further in Q Compared with the previous quarter, employment in Q2 rose by 167,000 and unemployment fell by 132,000. Though youth unemployment, long-term joblessness, and the level of inactivity are all still too high, recent figures show steady improvements in all these areas. Underemployment is also still too high, and million people are working part-time because they could not find a full-time job. We expect UK unemployment to fall faster, and to a lower level, than we predicted in Q2. The improved outlook for unemployment in our new forecast is due to: - Higher GDP growth in 2014 & 2015 than we predicted in Q2 - Continued strong labour market flexibility, and - Larger than expected falls in the jobless total in recent months Our new forecast envisages that the unemployment rate will fall from 6.4% in Q to 5.5% in Q2 2015, 5.0% in Q2 2016, and to 4.9% in Q We are forecasting the jobless total to fall from million in Q2 2014, to million in Q2 2015, million in Q2 2016, and to million in Q2 2017, a net overall fall in total unemployment of 420,000 over the next 3 years. Employment will continue to rise in the next few years, but some factors would still exert upward pressure on unemployment, limiting the size of future net declines. Planned cuts in government spending will cause further public sector job losses. Gradual productivity increase will limit the need for new workers. Many inactive people will rejoin the workforce, thus slowing the net fall in the jobless total. Compared with Q1 2008, output per hour worked is now more than 4% lower. Our forecast envisages modest increases in productivity from current low levels. However, productivity is unlikely to improve to its pre-recession levels in the next three years. A temporary decline in productivity is acceptable during a recession, because it alleviates human misery and helps businesses to retain skills. However, if productivity fails to recover as the economy returns to growth, living standards will suffer in the long-term. Table 4 summarises our forecasts for UK unemployment and productivity BCC UK Economic Forecast Q PAGE 10 OF 14

11 Table 4: UK labour market: total unemployment and youth unemployment Actual Forecast Q2 13 Q1 14 Q2 14 Q2 15 Q2 16 Q2 17 Unemployment rate, % 7.8% 6.8% 6.4% 5.5% 5.0% 4.9% Unemployed, 000s Youth Unemployment rate, % 21.4% 18.9% 16.9% 15.1% 14.0% 13.8% Youth Unemployed, 000s Youth unemployment 767,000 people aged 16 to 24 were unemployed in Q2 2014, down 102,000 from Q1 2014, and down 206,000 from Q These were the largest quarterly and annual falls in youth unemployment since comparable records began in The unemployment rate for people aged 16 to 24 was 16.9% in Q2 2014, down from 19.0% for January to March In line with international definitions, the unemployment figure includes 265,000 people in fulltime education who were looking for part-time work. With total UK unemployment forecast to fall to million in Q (a jobless rate of 4.9%), we are forecasting that total youth unemployment (people aged 16 to 24) will fall from 767,000 in Q2 2014, to 636,000 (a jobless rate of 13.8%) in Q2 2017, a net fall of 130, BCC UK Economic Forecast Q PAGE 11 OF 14

12 Inflation and labour costs Annual consumer price inflation (CPI) was 1.6% in July 2014, down from 1.9% in June Annual CPI inflation has been below the 2% target in each month since January Annual retail price inflation (RPI) was 2.5% in July 2014, down from 2.6% in June Having reached a peak of 5.2% in September 2011, CPI annual inflation has recorded large net falls in recent years. Our forecast is that CPI annual inflation will remain relatively stable over the next 2-3 years, staying most of the time slightly below to its 2% target. Global energy and commodity prices are likely to remain relatively subdued, sterling is likely to weaken very modestly, and rises in real earnings will broadly match productivity growth. In annual average terms, we are forecasting annual CPI inflation at 1.8% in 2014, 1.9% in 2015 and 2.0% in In Q2 we predicted 1.9% in 2014, 2.0% in 2015, and 2.1% in For annual average RPI inflation we are now predicting 2.7% in 2014, 3.0% in 2015 and 3.5% in In Q2 we predicted 2.8% in 2014, 3.0% in 2015 and 3.3% in Table 5 summarises our specific forecasts for CPI & RPI inflation. Table 5: UK Annual Inflation, % Change Year on Year CPI 4.5% 2.8% 2.6% 1.8% 1.9% 2.0% RPI-All Items 5.2% 3.2% 3.0% 2.7% 3.0% 3.5% Annual growth in total pay (average earnings including bonuses) was -0.2% in the three months to June 2014, compared with 0.4% in the three months to May 2014, and 1.9% in the three months to March Annual growth in regular pay (excluding bonuses) was 0.6% in the three months to June 2014, compared with 0.7% in the three months to May 2014, and 1.3% in the three months to March Looking forward, we expect earnings growth to edge up slowly in the next few years, in line with higher productivity and stronger economic activity. Annual growth in pay will move above inflation from Q onwards. Our forecast assumes that total earnings growth (total pay including bonuses) will average 1.5% in 2014, 2.9% in 2015 and 3.5% in BCC UK Economic Forecast Q PAGE 12 OF 14

13 UK public finances In 2013/14, underlying public sector net borrowing (excluding temporary effects of financial interventions, excluding the effects of the transfer of the Royal Mail Pension Plan, and excluding the transfers from the Bank of England Asset Purchase Facility Fund) was billion, 6.5% of GDP and 9.3bn less than in 2012/13. Public sector net debt excluding temporary effects of financial interventions (PSND-ex) was 1,299.4 billion at the end of July 2014, equivalent to 76.5% of gross domestic product GDP. Eliminating the structural budget deficit remains a hard but necessary job. The OBR forecast, outlined at the time of the March 2014 Budget, is realistic in predicting steady falls in borrowing. But the OBR s timetable is slightly too ambitious in our view. While the OBR is forecasting that UK public sector net borrowing would move into a small surplus in 2018/19, our view is that achieving this aim this would take 1-2 years longer. In spite of continued GDP growth, the economy s capacity to generate tax receipts has been damaged considerably, and this would delay progress in cutting the deficit. Further cuts in current spending plans will be needed, at least until the end of the decade. 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 Underlying PSNB-BCC forecast-finyears-%gdp 7.6% 7.3% 6.5% 5.8% 4.4% 3.1% Underlying PSNB-BCC forecast-fineyears- bn Underlying PSNB-OBR forecast-finyears-%gdp 7.9% 7.3% 6.6% 5.5% 4.2% 2.4% Underlying PSNB-OBR forecast-finyears- bn Note: Figures show underlying PSNB - excluding financial interventions, Royal Mail, and transfers from the Bank of England Asset Purchase Facility. Negative PSNB indicates surplus BCC UK Economic Forecast Q PAGE 13 OF 14

14 Policy issues The UK recovery is now gathering momentum. But growth is not sufficiently balanced. The recovery is not relying enough on net exports and investment. The messages in this forecast are positive overall, with upward revisions in GDP growth and employment. But many risks persist. There is progress towards rebalancing but it is too slow. While the trade balance is slowly improving, the current account deficit has worsened sharply, as the income balance that is traditionally in surplus has moved into large deficit. Businesses will face political uncertainties in the next few years: the Scottish referendum in September, the 2015 General Election, and a possible in/out EU referendum before To sustain growth, we need consensus across the political spectrum over measures that will enable business to plan and invest whatever the outcome of the various votes. The MPC must reassure businesses that, when official rates start rising, increases would be modest and gradual, so that unwelcome surprises are avoided. Even with greater clarity over policy, growth is likely to slow markedly after mid-2015, as higher interest rates put pressure on the finances of indebted households. With the right policies, business will still be able to drive recovery forward, albeit at a more modest pace. Contact details David Kern, Chief Economist at the BCC david.kern@btinternet.com BCC UK Economic Forecast Q PAGE 14 OF 14