UK: Decent Growth in an Uncertain World

Record employment and strong business investment are strengthening growth stemming from outside financial services and government spending. On the other hand, excesses in the housing market, weak exports, troubles in Europe, and a continuing drop in real consumer incomes make the outlook for next year modest at best.

By Ian Stewart, Chief Economist, Deloitte UK

The standout feature for the United Kingdom in the last year has been the pace of activity. GDP has increased by 3.0% over the last year, making the United Kingdom one of the world’s fastest-growing developed economies.
Activity is rebalancing away from finance and government. Output from the financial and insurance services sector, one of the super-growth sectors of the boom years, is in its sixth year of decline. Government spending is growing more slowly than GDP as the drive to reduce the public sector deficit continues.
Over the course of the year, manufacturing output growth has outstripped activity in the wider economy. The construction sector, which suffered two deep recessions in the last six years, is expanding strongly, helped by a surge in house building. Employment has reached a record high, with unemployment back to levels last seen in 2008.
The United Kingdom’s fastest-growing sector is professional and business services. This sector accounts for 11% of GDP (now more than manufacturing) and covers services provided to the other businesses, including law, accountancy, architecture, consulting, scientific research, and business support services. Output growth here has risen by a heady 9.1% in the last year.
During the recession, companies hunkered down, saving rather than investing or expanding, and became major providers of capital to the rest of the economy. Investment plummeted, and the corporate sector financial surplus—a rough proxy for corporate saving—rose.
This is changing. In the last year, business investment rose by 10.6%. In a sign of growing confidence, the corporate sector financial surplus is shrinking. Corporates are prioritising expansion over strengthened balance sheets. A recovery in investment offers the prospect of more balanced and sustainable growth.
Summer jitters over Scotland’s independence referendum and geopolitical worries from Ukraine and the Middle East did not arrest the uptrend in corporate risk appetite. In September, a record 72% of CFOs in the Deloitte CFO Survey said that now was a good time to take greater risk—a seven-year high. For CFOs, the external negatives seem to have been offset by good news on the US and UK economies, plentiful liquidity, and a feeling that the policy environment in the United Kingdom is pretty benign.
With inflation likely to run below its target over the next 18 months, the Bank of England seems likely to aim for gradual increases in interest rates, probably from early 2015.
After a grim few years, the United Kingdom is outperforming expectations as well as its peers. Yet it is not all easy sailing, and the United Kingdom is not immune to renewed fears that the global economy is running out of steam. The International Monetary Fund now sees a 40% chance that the Euro area—the United Kingdom’s largest trading partner—will relapse into recession. This appears to be affecting sentiment already, with the British Chambers of Commerce ringing the alarm bell for the UK recovery after manufacturing firms reported the weakest export growth in almost two years in its quarterly economic survey.
A slowdown in two of the world’s major emerging economies, Brazil and Russia, has further dampened spirits, while non-economic events such as the spread of Ebola, conflict in the Middle East, and continued fighting in Ukraine have added to the external uncertainties. These concerns led to a global sell-off in equity markets, with the FTSE 100 falling to its lowest levels of the year in October.
Moreover, some of the United Kingdom’s familiar problems have re-surfaced. The housing market has shown signs of excess. Productivity, or output per person, remains weak, as does the United Kingdom’s trade performance. Investment is way below its long-term levels, and consumer incomes are still falling. The government has been successful in cutting public spending, but tax receipts remain disappointingly weak as a result of weak income growth, and the deficit remains stubbornly wide.
This recovery is strong, but its sustainability will depend on how the United Kingdom deals with these challenges. Our expectation is that after a strong bounce in 2014 with the economy growing at around 3.0%, UK activity will decelerate modestly in 2015 to post growth of around 2.7%. Ultimately, however, much depends on how persistent and severe the slowdown in Europe is.