Following a difficult year, 2018 offers some reasons for optimism for UK consumers, with the EY ITEM Club forecasting falling levels of inflation and a modest revival in pay growth. However, the EY ITEM Club says that the good news will be offset by new headwinds including weaker employment growth, rising interest rates and more reluctance among consumers to ‘live beyond their means’.
UK consumer spending hit with new headwinds this year
The squeezed middle will continue to feel the pinch, says EY ITEM Club special report
According to the EY ITEM Club’s special report, consumer spending growth more than halved to 1.4% in 2017 from 2.9% in 2016 - the smallest increase since 2011. The report forecasts that consumer spending growth will see little change in 2018, running at 1.3%, before rebounding to 1.6% in 2019 and 1.9% in 2020.
Mark Gregory, EY’s chief economist, UK comments: “We are going to see stable but sluggish growth in consumer spending this year with little prospect of achieving the levels achieved in 2016. While the impact of higher inflation should slowly fade, the UK consumer will be hit by new issues which will impact their spending power.”
Inflation to fall over 2018, but pay growth prospects cloudier
Last year’s consumer price pressures was largely an exchange rate-driven phenomenon. The strengthening of sterling from the middle of 2017 should result in the currency effect now reversing. In addition, the EY ITEM Club’s forecast of two interest rate hikes to 1.0% in 2018 is expected to exert further pressure on inflation. Consumer Price Index (CPI) inflation is set to slow to an average of 2.5% in 2018, with the rate down to 2.1% by the end of the year, before falling to 1.9% in both 2019 and 2020.
However, falling inflation and accelerating growth in cash wages are unlikely to result in a significant boost for real household incomes. A tight jobs market, tentative signs of a recovery in productivity growth and increases in the National Minimum Wage (NMW) and the National Living Wage (NLW) would ordinarily point to a pick-up in pay rises. But, set against these forces, wage growth has continued to be unresponsive to low unemployment and structural changes, such as globalisation and off-shoring, have not gone away. Nevertheless, the EY ITEM Club expects a pick-up in average earnings growth to 2.7% this year from 2.4% in 2017, followed by further increases to 3.1% in 2019 and 3.3% in 2020.
Prospects for employment growth - another key driver of incomes – also look weaker than for some time. Employment and participation rates are close to their record highs, which reduces the room for further improvement. In addition, inflows of foreign-born people, which accounted for the large majority of UK workforce growth from 2012 to 2017, have fallen back. This is possibly the result of Brexit uncertainty, stronger demand for labour elsewhere in the EU and a weak pound. According to the report, employment is expected to grow by around 0.5% this year, which is down from 1% in 2017 and the 1.2% averaged since 2010. The LFS unemployment rate is expected to remain close to its current rate at 4.5%.
Squeezed middle continue to feel the pinch
While the EY ITEM Club expects a steady improvement in spending power for the average household from this year onwards, fortunes are likely to diverge across the various income groups.
Mark Gregory comments: “Workers at either end of the income distribution should fare best over the next few years. Lower earners will see their spending power boosted by further rises in the National Living Wage (NLW) and falling inflation in the food, petrol and energy categories, while those at the upper end will benefit from skills shortages pushing up wages. The middle will remain squeezed, earning too much to benefit from the NLW, losing support from over-indexation of tax thresholds, and automation subduing their wages.”
The EY ITEM Club says that consumers in the lowest income decile will see their take home pay grow 5% this year and 4.5% in 2019, while higher earners in the 90th income decile will see growth of 3.2% and 2.9% respectively. In contrast, those in the median income decile, earning around £28,000 per year, will see their take home pay increase by 2.9% this year and 2.5% next year.
Retailers will need to fight smart for share of spend
Julie Carlyle, Partner and UK Head of Retail, EY says: “The consumer wallet will be stable at best going into 2018, and for retailers it will be key to work out how they can fight for their share of spend. However, they need to fight smart and not just hard. To do this they will need to look at what their competitors are doing, gain a better understanding of their own target customers and provide them with the right experience. They also need to have real clarity around their brand and purpose, this matters to an ever increasing extent.
“The boost to spending power for those at both the top and bottom of the income groups is also likely to increase the influence of retail disrupters. Value disrupters in the supermarket space are more likely to thrive, while retailers offering specialised products and luxury goods will benefit from the additional spending power of higher earners. It’s the traditional goliaths of the retail industry who perhaps face the biggest challenge, with middle income earners continuing to feel the pinch.”
Unspectacular growth set to continue
Concluding, Mark Gregory says that the dominant role played by consumer spending in the economy - representing just under 65% of GDP - will inevitably have a big impact on UK growth.
“Our prediction of a ‘so-so’ consumer sector over the next few years points to a ‘so-so’ economy, growing at an unspectacular rate compared with past standards. However the fact that consumption is projected to grow broadly in-line with incomes suggests that the economy should avoid the excesses of borrowing, credit and debt that preceded the last recession. The odds of the current economic expansion proving long-lasting, if not particularly strong, are perhaps enhanced by an insipid consumer performance.”
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