Light at the end of the tunnel?

Uncertainty has been the dominant theme of the EY ITEM Club forecasts over the last three years since the Brexit referendum. With the UK recently agreeing a Withdrawal Agreement with the European Union (EU), hopes were raised that we might be about to move forward with more certainty. However, with the Agreement yet to be passed by Parliament, the outlook remains unclear.

Expectations may have been running ahead of themselves in any case. The Withdrawal Agreement only covers the next 14 months and as it defines the terms of the UK’s exit, it offers almost no additional guidance on the future of the UK’s trading and other relationships with the EU after 2020. In so far as we can glean anything about likely conditions after 2020, the Political Declaration suggests a much less comprehensive relationship than currently exists, which, other things being equal, the majority of forecasters believe is likely to mean a slower rate of UK GDP growth after 2020 as compared to staying in the EU.

Or more of the same?

In truth therefore, little has changed in the short term and as a consequence, the EY ITEM Club Autumn Forecast 2019 maintains the GDP growth projection of 1.3% for 2019 from the Summer Forecast 2019. More interestingly, the latest forecast markedly cuts expected expansion in 2020 to 1.0% from the 1.5% rate previously expected. This downgrading of growth in 2020 reflects an assumption that the UK will leave the EU at the end of January, the fact that uncertainty has not been significantly reduced by the UK and EU agreeing a Withdrawal Agreement, and that the EY ITEM Club now believes that the lack of clarity over the future UK and EU relationship will limit any recovery in business investment in the immediate future more than previously thought.

Despite concerns over uncertainty, it is interesting to note that the economy performed largely as expected over the past three months following the path set out in the Summer Forecast. GDP contracted 0.2% quarter-on-quarter (q/q) in Q2 2019, and it currently looks like expansion of 0.4% q/q occurred in Q3. However, this was buoyed by strong growth in July and largely weak news on the economy for August and September indicating that heightened Brexit, domestic political and global economic uncertainties are combining to create a very challenging environment.

With no clear pattern …

Despite a relatively steady quarter, the economy does remain difficult to understand because the individual components are likely to develop in different ways:

• Consumers are benefitting from better fundamentals but signs of softening in the labour market may add to the growing weakness in their confidence and limit any increases in spending;
• The global economy is under pressure with concerns over geopolitics and trade weighing down on activity and trade is unlikely to contribute much to UK growth;
• On a positive note, fiscal policy will be more supportive than previously planned following Chancellor Sadiq Javid announcing in the Spending Review for 2020/21 that public spending will rise 4.1% in real terms, the fastest increase in 15 years. It is also highly likely that the Budget for 2020/21 will contain further fiscal loosening measures.

… plan for the worst …

There is no obvious boost to growth in sight and investment analyses will remain difficult in this environment, due to the lack of clarity on the UK and EU relationship after 2020. It is certainly possible that agreeing a future relationship will not be possible in 14 months and the UK will then either find itself without a deal or will extend the transition period. Businesses should continue to plan for low growth and have contingencies around a possible future No Deal scenario, while at the same time developing options for future investment that can be realised once more clarity emerges. The next 12 to 18 months are likely to be volatile, with the potential for sentiment to shift quickly in response to political developments.

… and look to the future.

It is important not to let the short-term concerns stop businesses from thinking long term. I have been struck in recent weeks by just how significant concerns over the climate emergency and its potential implications for business have become. Combine these potential impacts with the changes that Brexit and technological change could bring to markets and supply chains, and it is clear that strategic thinking is required to identify the way forward in a dynamic economy. There will be winners and losers in this changing environment and companies need to do the work now to ensure they come out on the right side of the line.