A squeeze on consumer spending from rising inflation and underwhelming earnings growth is expected to hit UK growth this year and next, but Britain’s medium-term future is looking considerably brighter.
According to the EY Item Club summer forecast, while the General Election result was a shock, it has increased the likelihood of a Brexit transition arrangement, followed by a free trade agreement. Those should provide greater certainty to help spur business investment, along with a looser fiscal stance.
Combined with the expectation that inflation will drop back to the target by the end of next year, the EY Item Club forecasts GDP growth of 1.3 per cent in 2018 and 1.8 per cent for 2019; an increase from the previously predicted 1.2 per cent and 1.5 per cent.
Peter Spencer, chief economic advisor to the EY Item Club, said:
Although the General Election has clouded the issue, it should result in a softer Brexit, meaning a transition arrangement, leading to a comprehensive free trade agreement further down the time-line.
The outlook for this year has deteriorated since our spring forecast, but a softer Brexit should improve the medium term outlook - especially in sectors like the motor industry where investment has been held back by Brexit uncertainty.
Chancellor Philip Hammond said today he believed there was widespread support for the transitional Brexit deal favoured by business, and that the "great majority" of his colleagues recognise it is "the right and sensible way to go".
Despite the renewed hopes of a softer Brexit, the EY Item Club does expect business investment to be flat in 2017, followed by growth of 0.1 per cent in 2018. Assuming that the UK secures a transition agreement after Brexit and moves towards a free trade agreement, the EY Item Club anticipates business investment to strengthen to 2.1 per cent in 2019.
EY's chief economist Mark Gregory said firms face a tricky balancing act of steering through a difficult 12 months of “stuttering UK growth”, while still creating the basis to grow if the medium-term outlook improves as predicted. “If businesses want to make the most of improving export markets and a more competitive pound, they will need to invest ahead of the recovery in the economy,” Gregory added.
There will be more bumps in the road ahead though, with the forecast expecting pressure on consumers to grow this year, before eventually lifting towards the end of 2018. With sterling's slump in the wake of the Brexit vote last June still to fully feed through the CPI index, CPI inflation is expected to reach 3.2 to 3.3 per cent this autumn, considerably ahead of the growth in average earnings.