Consumer spending will continue to be the main driver of the economy this year, though if business investment fails to return in 2017 growth could falter, the EY Item Club think tank has warned.
Consumer spending is expected to grow by 2.5 per cent in 2016, but slow to 2.1 per cent in 2017 as rising inflation and a renewed fiscal squeeze tightens purse strings.
Business investment should however accelerate to 7.8 per cent in 2017 from a modest 3.2 per cent this year as uncertainty from domestic and overseas factors eases.
If business investment does not pickup though it could spell bad news for the UK economy.
Peter Spencer chief economic advisor to the EY ITEM Club, said:
Although the financial markets may have recovered their poise, questions about emerging markets and the global economy remain unresolved. At home uncertainty surrounding the outcome of the EU referendum may hit business confidence and corporate appetite for risk. We are at a tipping point and, if the predicted growth in business investment doesn’t come through, the long term sustainability of an economy running on a single engine fuelled by consumer spending will look increasingly doubtful.
GDP growth is expected to reach 2.3 per cent this year, mostly due to consumer spending.
In 2017, overall investment is expected to add 1.2 per cent to output, which should offset the expected slowdown in the consumer sector and pushing growth up to 2.6 per cent.
The rise in investment from businesses next year will be fuelled by the fading uncertainty surrounding the outcome of the EU referendum and growth in UK’s main export markets in the US and the EU.
The EY Item Club's predictions are based on the assumption that the UK will remain part of the EU and would have to be recalculated if the country votes to leave on 23 June.
Housing investment is also expected to recover as well as public investment to hold steady. This will push total investment growth from three per cent in 2016 to 6.7 per cent in 2017 and then 5.5 per cent respectively in the following two years.
UK companies continue to run substantial financial surpluses, amounting to £32bn in 2015. They have been reluctant to invest in tangible assets such as plant and machinery. Conditions from the second half of this year should strongly favour investment.
Last year saw the household saving ratio drop to just 3.8 per cent in the final quarter, the lowest since records began in 1963. But according to the EY Item Club, this does not point to a debt-fuelled consumer boom.
Instead, prompted by ultra-low interest rates, households have been shifting cash from low-yielding financial assets to housing.
Households invested a record £95bn in housing last year, 7.8 per cent of their disposable income. In contrast, their investment in financial assets, net of sales, was just £28bn, lower than at any time since records began in 1987.