The UK economy will grow faster in 2014 than any other G7 economy, an influential report has forecast. UK GDP growth will hit 3.1% this year, spurred by strong capital investment by businesses, the EY Item Club has said.
As business investment ramps up, taking the pressure off consumer spending, which has largely driven the recovery, the UK economy will continue to step up a gear according to the forecast. Output is forecast to increase by 3.1% this year, moderating to 2.5% next year, as the economy settles down into a steady expansion. The labour market is performing very well, holding out the promise that this expansion can be sustained for a long time, without the issues associated with excessive inflation or credit growth.
The supply of labour is broadly keeping pace with the demand for extra staff and is boosting household incomes and spending through increases in employment rather than wage inflation. The saving ratio has been stable over the last year at just below 5%, unlike the previous twelve months when the growth in spending was financed by a fall in saving. The UK labour market is very strong overall and the unemployment rate fell below the Monetary Policy Committee’s base rate guidance threshold of 7% early in the year.
One important factor is the currently level of wage inflation, which is helping to rebalance the economy by curbing encouraging consumption growth and supporting investment & exports by restricting interest & exchange rates. The exchange rate is up 12.5% on the year, however, would be a much higher if wages were seriously picking up. Productively, housing investment is recovering well and business investment is being ramped up as companies put their cash piles to good use and make up for the decreased levels of investment seen since the financial issues of a few years ago.
Looking towards the forecasts, it shows that investment is providing nearly half of the increase in demand over the next few years, with the rest coming largely from consumption. Net trade is unlikely to make a significant contribution early on and should increase in the later years of the forecast. Business investment is set to increase by 12.5% this year followed by 9.7% in 2015. In addition to this investment housing investment is likely to accelerate from 7.6% growth this year to 13.4% in 2016.
Export growth is slowly increasing as service exports are much more diverse and now have a better market focus. The UK has consistently decreased its share in the world market for goods, however, has maintained its strong position in the markets for services. EY Item Club expects the growth in demand for these exports to increase the surplus on services from £60 billion in 2012 to £113 billion by 2018, adding to demand as well as helping the balance of payments. Exports remain heavily dependent upon European and other traditional UK markets. These markets are expected to grow by 4.9% this year and 5.3% in 2015 recovering from 2.0% in 2012 and 2.6% last year. This recovery is reflected in the forecast of exports, which accelerate from 0.5% last year to 1.9% this year and 5.4% next year. With the UK growing faster than most other economies, imports will also pick up, growing by 2.5% this year and 6.0% in 2015, before easing back to around 4% in the last two years of the forecast, ending in 2018.
Most interestingly, many experts have recently had differences in opinion on whether to raise interest rates. The report suggests that the markets expect a base rate rise by the end of this year. Indeed, with recent indicators pointing to acceleration in growth, the Governor of the Bank of England Mark Carney has stated that interest rates could begin to increase earlier than people think.
What do you believe is best path for interest rates in the UK?