March 2017

WARWICKSHIRE MEANS BUSINESS

'Irrational' consumers drag the UK economy forward

In a period not short in uncertainty, the economy has responded surprisingly well to the adverse conditions it has faced and continues to face.

In February, the Bank of England revised its estimations for growth in 2017 upwards to 2.0%, as did the Office for Budget Responsibility just last week. This positive move has been in light of greater-than-expected demand in the economy - the British consumer continues to spend despite the pound being worth less abroad. Businesses are spending more with the cheap availability of corporate credit, and exports are increasing in the face of more competitive UK goods and services.

Greater demand has led to growth in production activity, primarily due to increased manufacturing output. Although impressive, the manufacturing industry only accounts for 20% of UK output and is heavily influenced by movements in the export market. As we begin our potentially acrimonious exit from the EU, the sustainability of this growth is uncertain.

Economists’ underestimation of current economic activity is due to the seemingly ‘irrational’ consumer dragging the UK economy forward. Industries servicing Britain’s shopping habits have accounted for a quarter of growth since the referendum, according to the Financial Times. Thus, small changes in consumer spending can have big implications. The recent devaluation of the pound has led to an inflation rise, reducing real household disposable income.

With lower incomes, consumers were expected to spend less; however, this seems to have been counter-balanced by record-high employment levels. Especially in Warwickshire, where the employment-rate suggests that eight in 10 people are in work, average household incomes have increased. Furthermore, spending is rising faster than income, which can be financed through savings, which has fallen in recent times, or credit, which has increased.

The good news nationally has been mirrored locally. Recent figures released by the Office of National Statistics show that Warwickshire’s productivity growth is outperforming nine in 10 local authorities in the UK. Since the recession, productivity in terms of output per worker has risen 19.6%, despite UK productivity only reaching pre-crisis levels in October of last year.

Productivity, a key indicator of an area’s growth potential, has blossomed in response to GVA and employment growth in Warwickshire’s key sectors; businesses growth has been strong and the survival rates of businesses have improved, creating a more stable and competitive platform for businesses to thrive and innovate. Additionally, the workforce has become more skilled, with 40% fewer 16-24 year olds having no qualifications.

Warwickshire’s status as a ‘driver of UK productivity growth’ has lifted the CWLEP’s level of productivity to a level higher than the average UK LEP area for the first time in eight years. Coventry has also contributed significantly, closing the productivity gap with other UK local authorities since 2009.

The outlook for the coming months should, however, remain conservative. Inflation is expected to rise as a result of higher domestic and international spending. This will squeeze real income and taper wage growth. Indeed, January has seen retail prices rise 1.9% and spending growth increase at its lowest since November 2013.  

Perhaps more concerning is that those on lower incomes are likely to face higher personal rates of inflation, as a greater proportion of their incomes are spent on items that are facing potentially the highest price increases.  Food price inflation doubled between January and February reporting periods (rising from 0.7% to 1.4%), with some goods such as butter (+15.8%), fish (+8.8%) and tea (+6%) increasing sharply. Energy and fuel costs are also expected to increase over the coming months.

Despite this rising inflation, the BoE doesn’t anticipate raising the interest rates any time soon (which would be the normal reaction to above target inflation levels). This is to avoid the risk of hurting the tempered growth we are encountering.  It is, however, interesting to note that the Federal Reserve in the US will be increasing their interest rates shortly, and have already indicated sustained upward movements during 2017. 

It would seem, therefore, that the US economy has greater resilience to withstand such rises that the current UK position. Furthermore, such a rate rise will make the dollar a more attractive investment proposition which is likely to continue to keep the pound low – with knock-on consequences for import and export costs.

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