Economic slowdown is underway as consumers rein in spending

24 April 2017

By Andrew Sentance, Senior Economic Adviser, PwC

Consumers are reining in their spending after a post-referendum shopping spree. That is the message from last week’s retail figures which showed a fall of 1.4% in sales volumes between the final quarter of last year and the first three months of 2017.

Such a big fall in retail sales volumes is very unusual. Since the mid-1990s, we have only seen one quarterly spending drop bigger than this - when the temporary cut in VAT came to an end in early 2010. Even in the depths of the financial crisis, retail sales did not fall as sharply in a single quarter.

The strong surge in consumer spending which started in 2014 - and continued through 2015 and 2016 - has come to an abrupt end. This is not just because consumers are taking a breather – there are more significant forces at work.

The first is the rise in inflation, which has eliminated the positive gap between wage increases and price rises, which had been very supportive of consumer spending growth in the period 2014 to 2016. Inflation has now risen to 2.3% and most forecasters expect it to go higher – to 3% or more - as rising import costs feed through to consumers.

It is not only wage-earners who will be squeezed by rising prices. Pensioners and others who rely on income from savings will also suffer. The inflation rate is soon likely to overtake the 2.5% increase in the basic state pension taking effect this month. Meanwhile, people living on savings interest continue to receive a rock-bottom return with the official Bank Rate at 0.25%.

A second drag on consumer spending is slower growth of employment. UK employment is now rising at around 0.1-0.2% a year compared with the average growth of 1% over the past twenty years. This reflects a combination of demand and supply factors – including a drop in workers coming from other EU countries and lower participation by older workers in the workforce.

The third factor which could come into play is a change in saving and borrowing behaviour. Over the past few years, consumers have been willing to increase their borrowing and run down savings. This has taken the household saving ratio to a historically low level. However, consumers cannot increase borrowing and run down savings indefinitely. At some point they will start to rebuild their financial balances, exerting a further brake on consumer spending.

We now face a much more subdued contribution from consumers to economic growth. That will leave the outlook for the UK economy more dependent on the growth of exports, government spending and investment.

On the export front, there are grounds for optimism – at least in the short-term. According to the IMF’s latest forecasts, 2017/18 will be the strongest period of global growth since 2011/12. There are fairly solid grounds for this positive outlook. All the main regions of the world economy – North America, Europe and Asia – are now growing reasonably well.

Though there is limited scope for government spending to provide a strong boost to the UK economy, the Chancellor Philip Hammond increased spending in a number of investment areas in last year’s Autumn Statement – including transport and housing. Infrastructure spending will therefore provide some modest support for the economy over the year ahead.

The outlook for private sector investment, however, is less positive. Capital spending by businesses fell last year by 1.5% - for the first time since the financial crisis. Uncertainty surrounding the Brexit referendum and the decision to leave the EU probably contributed to this investment downturn. This uncertainty is likely to continue to hold back business investment during the Brexit negotiation process over the next couple of years.

Putting all these pieces of the economic jigsaw together points to an economic slowdown, driven by a consumer squeeze and subdued business investment. But exports and government spending should provide some offsetting positive support.

Economic forecasters have been pointing to a slower economic growth since the Brexit vote, but the strength of consumer spending in the second half of last year appeared to confound these warnings. The latest retail sales figures are the clearest indication yet that this expected economic slowdown is already underway.

This blog is an edited version of an article which was first published in the Daily Telegraph on 22 April 2017.

Andrew Sentance:
Read profile | Contact by email | Tel: 020 7213 2068

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