Date: 13 May 2016
The forecast shows growth of 2.3% in GDP this year. This is in line with the latest estimate for 2015, which was heavily dependent upon the consumer, supported by the strong labour market and low inflation.
Although these tailwinds remain in place this year, households are unlikely to be able to sustain this drive for much longer as inflation and austerity progressively undermine the growth in real disposable income. Household spending has also been growing faster than income, cutting their saving ratio to an all-time low of 3.8%.
The household financial deficit also reached a record £43bn in 2015. However, that reflects the high level of spending on housing rather than consumption. Households invested a record £95n in housing last year, 7.8% of their disposable income. In contrast, their investment in financial assets, net of sales, was just £28bn, lower than at any time since this series began in 1987.
It seems clear that the low interest rates and high equity prices engineered by central banks in response to the financial crisis have encouraged households to invest in housing rather than low-yielding financial assets. This is the main reason why their move into heavy financial deficit has not been accompanied by the surge in bank borrowing that EY saw in the run up to the crisis in 2007.
On this analysis, the economy is less prone to a banking crisis than it was then. Nevertheless, in EY’s view the high level of house prices relative to income does pose a risk to financial stability. Affordability also poses a risk to social cohesion, threatening to lock younger generations out of the housing market.
Companies have been reluctant to follow consumers in switching from financial to real investment. They continue to run huge financial surpluses, amounting to £32bn in 2015. Companies hit the pause button last summer as risk appetite was undermined by uncertainty about the global economy and this year’s referendum on EU membership.
The forecast is constructed on the assumption that the UK remains a member of the EU following the referendum. On this view, EY should see a rebound in investment following the vote, as spending held back by the associated uncertainty comes through. Profitability in most sectors is moving up to progressively higher levels, while the return on financial investments is progressively depressed. The cost of labour is also rising as the Living Wage is introduced and levies on businesses are increased.
On this view, investment adds 1.2% to GDP next year, making up for the expected slowdown in the consumer sectors and pushing the growth rate up to 2.6%. However, that looks like the high point in this cycle as inflation progressively saps consumer spending power and austerity tightens its grip on consumers and companies alike.