Optimistic outlook for the UK economy

The UK economy continues to expand at a solid pace with GDP growth revised up...

The UK economy continues to expand at a solid pace with GDP growth revised up by 0.2 percentage points from its previous estimate to 2.8% in 2014, despite a modest slowdown in the last quarter. Recovery continues to be underpinned by stronger consumer spending and business investment, the former boosted by persistent employment growth and a long-awaited increase in real wages. In addition, the economy has benefited from falling global oil prices. Nevertheless, headwinds remain over the forecast period, primarily due to domestic political uncertainty, global challenges and a stronger Sterling weighing down UK export growth to the Eurozone.

The UK’s star performer, the services sector, experienced output growth of 0.9% quarter-on-quarter in 2014 Q4. Manufacturing output growth slowed in the fourth quarter and a contraction of 2.2% was recorded for construction. Still, both are expected to positively contribute to GDP growth going forward. We forecast GDP growth of 2.7% and 2.6% in 2015 and 2016 respectively.

The most noticeable impact of the hefty fall in global oil prices since mid-2014 has been on prices for consumers and manufacturers. CPI inflation fell to a record low of 0.0% in February and March from 0.3% in January as a result of cheaper energy and food prices. This increases the uncertainty over the first interest rate hike. Base rate has already been held at 0.5% for over six years, undoubtedly longer than anyone would have thought back in 2009, but the Association expects tightening of monetary policy to occur in 2016.

Lower inflation, in turn, has amplified the effects of improvements on the labour side. The strength of the labour market has been reflected by the employment rate which hit a record high of 73.4% in February.  Similarly, the unemployment rate has fallen successively since 2011, to 5.6% in the three months ending February down from 5.8% in the three months to November 2014, with this trend expected to continue over the year.

The combination of lower inflation bringing about real wage growth has also been more pronounced on consumers, strengthening their purchasing power. Household consumption increased by 2.5% in 2014 and growth is forecast to average around this rate over the long term. Business investment recorded strong growth of 7.8% in 2014, with growth expected to moderate gradually thereafter in each year until 2018. Investment in oil and gas already constrained by oil prices has suffered significantly reflected in a lack of new construction orders since 2014 Q2.

Despite an optimistic outlook for the UK economy, risks from the global backdrop remain due to a slowdown in growth across key economies. Over the medium-term, the IMF expects modest growth of 3.5% in 2015, followed by 3.8% in 2016. In the Eurozone, regardless of a slight pick up in the last quarter of 2014, growth remains anaemic. Key elections in Spain, Portugal and France this year are set to intensify concern over the direction of economic policy.

Finally, uncertainty around the General Election here poses the largest risk to the outlook. With the outcome difficult to predict, but with several combinations of coalition likely to raise the possibility of an EU referendum, there could be some damage to business confidence and, consequently, business investment and economic growth.