UK Economy

The UK’s economic prospects continued to brighten during the course of the last year.  The UK economy grew strongly in 2014, by 2.6%, and the consensus of current forecasts published by HM Treasury is that that this will be sustained with growth of 2.7% in 2015.

The UK unemployment rate fell to 5.5% during the three months to March 2015 according to ONS estimates; its lowest level since mid-2008. The number in employment was estimated to be 202,000 higher than during the preceding three months, and 564,000 higher than a year earlier. Moreover the employment rate of 73.5% is the highest since comparable records began in 1971.

Moreover, the latest estimates indicate that continued growth in employment is due mainly to increased numbers of employees. Earlier figures had suggested that a large proportion of employment growth was due to people becoming self-employed, possibly reflecting a lack of opportunities elsewhere in the labour market. However compared to a year ago the number of self-employees has now fallen, whereas the number of employees has risen by 2.5% over the last year.

UK Labour Market Statistics and Inflation (%)

Source: ONS. Average earnings excluding bonuses and arrears.

Since the final months of 2014 there has also been some uptick in average earnings; following nearly five years of falling real incomes. Average earnings, excluding bonuses, were 2.2% higher than a year earlier during the three months to March. This was the strongest improvement since mid-2011; but remains below the long run average. During the seven years up to the end of 2008, average earnings grew by 4% a year.

However the recent sharp fall in inflation means that the pressure on consumer’s finances is beginning to ease. The UK CPI inflation rate fell to zero in February and March, before dipping into negative territory in April. The April decline was the first  time the CPI has fallen over the year since official records began in 1996 and the first time since 1960 based on comparable historic estimates. The fall is in part due to weaker global oil prices that have fed through into lower fuel prices for UK consumers, especially motorists. In addition falling food prices, aided by a supermarket price war, have also pushed the inflation rate down. The drop in the price of these staple items is expected to boost households discretionary spending on goods and leisure and spur UK economic growth.

Indeed ONS recorded a 1.2% rise in retail sales volumes during April, leaving sales volumes 4.7% up on a year ago. This was the 25th consecutive month of year-on-year growth, the longest period of sustained growth since May 2008. The latest CBI Distributive Trades survey indicates that the upward trend continued during May, with 60% of firms reporting that their sales volumes were up on a year ago and only 9% reporting a decline. Most retail sub-sectors reported robust growth in sales volumes including grocers and non-specialised stores, which rebounded from negative showings in the previous month to report strong performances.

Recent signs of a tempering in the rate of economic growth have seen expectations of an interest rate rise pushed back, with most analysts now expecting a rise in the final months of 2015 or the first half of 2016. Following the sharp falls in inflation, the Bank of England’s monetary policy committee has voted unanimously to keep interest rates at 0.5%. This is a departure from previous meetings; from August to December two of the nine member committee had consistently voted to raise rates.

Looking ahead, the Office for Budget Responsibility’s most recent forecast, released alongside the Budget in March, anticipates unemployment falling to 5.3% in 2015; much faster than their forecast made 12 months earlier which saw unemployment only falling to this level by 2018. Earnings growth is expected to outpace inflation during 2015, gradually restoring the real value of wages before accelerating in 2016. Consumer confidence is increasingly being driven by expectations of personal household finances, rather than expectations of house price growth.  

OBR Forecasts, March 2015

Encouragingly, the ONS has recorded a strong rising trend in business investment since mid-2013. Business investment in the final quarter of 2013 rose 2.7% on the previous quarter and was 7.1% higher than the year before. Business investment continued to pick up sharply during the first half of 2014, rising to 11% higher than a year ago in the second quarter. However investment has since slipped, with weak growth of 0.3% in the third quarter followed by a 0.9% decline in the final quarter of 2014. Despite this weak second half to the year, 2014 as a whole saw a 7.5% rise in business investment; the strongest growth since 2007. Furthermore the business investment growth has resumed in the first quarter of 2015, rising by 1.7% on the final months of 2014 to stand 3.7% up on a year earlier. The latest median Treasury consensus forecast is for fixed investment growth of nearly 5% both this year and next.   

Key economic indicators

Sources: National Statistics, Bank of England

However the other key component to sustainable economic growth, a rise in UK exports, remains a significant challenge. Over the first 11 months of 2014 exports of goods (excluding oil) declined by 1% compared to the same period of 2013. The bulk of the recent upturn in manufacturing output has been a result of domestic consumption. In addition the strengthening UK pound, a result of the UK’s fast economic growth and expectations of an interest rate rise, will damage the international competitiveness of UK exporters. Renewed economic troubles in the Eurozone are also dampening UK manufacturers’ expectations of export growth.

UK Economic Growth & Construction

The UK economy saw anaemic growth in 2012, but revisions to ONS figures show that the UK avoided falling into a ‘double-dip’ recession. The same cannot be said of construction activity, which fell by 8.2% in 2012. UK economic growth then accelerated, with GDP showing rises of 3.1% in the second and third quarters of 2014 relative to a year earlier. This rate of growth has eased over the last two quarters to 2.4% on a year earlier.

Recent months have also seen a slowing in construction output, according to ONS figures. This is surprising, given the strength of project starts during late 2013 and 2014, which are a strong lead indicator of future output. Survey data, such as the Markit/CIPS PMI and industry association State of Trade surveys, also contrast with the view of falling output. According to ONS statistics, output fell by 2.2% in the final quarter of last year. This remained 4.5% higher than a year earlier. However a further 1.1% fall during the first quarter of 2015, left output 0.3% down on a year ago.

Government policy & finances: 2015 Budget

Inevitably 50 days before the General Election, the Chancellor’s attention was on short-term political priorities rather than long term investment needs. However, there was no big pre-election give away, with the Chancellor choosing to use better than expected government revenues to tackle the deficit more quickly than previous planned.

Nevertheless, the forecast faster growth in the UK economy and household incomes should bolster private housing and non-residential construction activity. Furthermore the Chancellor’s Budget proposals are centred upon supporting and encouraging private sector investment and economic growth. This included his ‘surprise’ move to create a Help to Buy ISA that will include a Government contribution of up to £3,000 for savers to help build up their deposit. Additional support for increasing new housing supply is being provided though the creation of the first 20 Housing Zones outside London with the potential to deliver 34,000 homes.

Elsewhere direct Government support is limited. £13 billion of planned departmental cuts during the next Parliament indicates that public funded construction work will remain under pressure under the Conservative government. Whilst funding support has been promised potentially for a few projects such as the Brent Cross regeneration scheme, the Croxley rail link and the Swansea tidal lagoon, the Chancellor’s focus was more on the Government’s enabling role. This includes the promised release of public sector land with capacity for up to 150,000 new homes between 2015 and 2020, while additional planning powers are promised for the London Mayor to accelerate new housing provision and pilot schemes in Greater Manchester and Cambridge & Peterborough will incentivise local authorities to support economic growth by allowing them to retain any additional increase in business rates. 

Economic Summary

The OBR is forecasting GDP growth of 2.5% this year, close to 2.4% expansion forecast at the 2014 Autumn Statement. This came despite deteriorating expectations for fixed investment, particularly into private dwellings but also due to weaker predictions of investment by businesses. Overall fixed investment is predicted by the OBR to have risen by 6.8% in 2014 and to rise by 4.3% in 2015; this compares to estimates of 8.1% and 8.4% respectively forecast three months ago. This was offset by an increase in forecast government consumption; now expected to rise by 0.8% in 2015, revised upwards from a 0.4% drop forecast in December. 

OBR Economic Forecast

Source: OBR – March 2015

The outlined spending plans, as with previous government spending plans, entail significant further cuts after the general election. The Chancellor’s speech stated that the spending plans require £30bn of savings by 2017/18; £13 billion of these would come from government department spending; £12bn from welfare and £5bn would be raised by combating tax avoidance and aggressive planning, if the Conservatives are given the keys to the Treasury in 50 days time.

However independent forecasts of UK public sector net borrowing have tended to be higher, perhaps due to questions over the political feasibility of further cuts to public services. According to consensus forecasts compiled by HM Treasury, the median forecast made over the three months to March were for PSNB to be £76.5bn in 2015/16 in 2015/16 and £57.6bn in 2016/17. These were of course made without knowledge of the Budget announcements, but were in each case around £7bn higher than the OBR’s Autumn Statement forecasts (£70.3bn in 2015/16 and £49.0bn in 2016/17).

Public Finances 

* Excludes Royal Mail and Asset Purchase Facility Transfers

Encouragingly, government investment is forecast to remain relatively stable in real terms, with reductions in public spending coming on the current account side. Gross Public Sector Investment is forecast to rise by just 1% in nominal terms during 2015/16, followed by rises of 2% per year for the next two years with increase further accelerating at the end of the forecast period once the Government deficit is eliminated.

The most marked change to forecasts of public sector net borrowing is for plans once the Budget is in surplus. Spending plans announced at the Autumn Statement contained a forecast surplus in 2019-20 of £23.1 billion. This would take public spending to 35.2% of GDP, the lowest level since the 1930s, and was seized upon by Labour campaigners arguing the Conservatives would cut back vital services. The new spending forecasts are for spending to level out at 36.0% of GDP from 2018-19, the same level as in 2000 when Gordon Brown was Chancellor.