23 January 2017

UK economy set for a ‘hard rebalancing’ says EY ITEM Club

The EY ITEM Club says that the impact of sterling in increasing import costs will see inflation rise to 3.1% by the final quarter of 2017, before easing back to 2% by the end of 2018. This is expected to have a knock on impact on consumer spending, as growth in disposable incomes is eroded. However, the weak pound and a softer domestic market are likely to encourage higher levels of UK exports, as businesses seek income opportunities overseas, resulting in exports increasing by 3.3% this year and 5.2% in 2018.

According to the report, this rebalancing of economic activity will be accompanied by three years of relatively slow growth. The EY ITEM Club expects GDP growth to reach 1.3% in 2017 (up from the 0.8% it predicted in October’s forecast, but down from an expected 2% in 2016) and just 1% in 2018. The MPC is predicted to hold interest rates at their current 0.25% until the spring of 2018.

Economic impact of Brexit ‘shallow but prolonged’

Peter Spencer, chief economic advisor to the EY ITEM Club, comments: “We now expect the impact of Brexit on the UK economy to be shallower, but more prolonged than we did in October. However, there is a sea change coming over the next three years. The fall in the pound will force the economy to be less reliant on consumer spending, leaving growth heavily dependent upon trade performance.”

Mark Gregory, EY Chief Economist, adds: “Whatever the outcome of the Brexit negotiations, there are clear indications that the fall in the pound and the UK’s exit from the EU will entail a change in the structure of the UK economy. The onus will be on businesses to adapt to the slowing domestic economy by seeking opportunities overseas.” [...]

Exports provide silver lining

The UK’s future growth is critically dependent upon a strong trade performance, according to the EY ITEM Club forecast. A more competitive trade sector means that, net exports are expected to add 0.8% to GDP in 2018 and later years. Along with the boost to the UK’s overseas income from sterling’s weakness, a stronger trade position means that the deficit on the current account is set to narrow from 4.5% of GDP this year to 3.7% of GDP in 2018 and 2.5% in 2019. [...]

Risks and uncertainties

Peter Spencer concludes: “The fall in the pound should help boost exports in the near term. However, trade performance and growth in 2019 and beyond will depend critically upon the exit terms that can be agreed with the EU27 and other countries. Theresa May has provided some clarity on the UK’s Brexit objectives. But with elections in the Netherlands, France and Germany due later this year, it will take longer to get the same clarity on the views of the EU27 and the shape of the ensuing negotiations.”

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