The FINANCIAL — The Bank of England has reduced its forecast for UK growth in 2015 to 2.9 per cent but our own assessment is that growth will be only 2.4 per cent. This is largely because we expect the domestic political situation and a cloudy outlook for the eurozone to increase economic uncertainty.
Combined with a slowing housing market and little sign of inflationary pressure, we now think UK interest rates may stay on hold until the first quarter of 2016 – a full year later than we had previously expected.
With demand in the core eurozone countries looking increasingly fragile, we lowered our 2015 growth forecast for the eurozone to 1.0 per cent, reducing UK export prospects. However, the slow pace of structural reform entails a constant risk of a sudden and/or disorderly eurozone slowdown.
The UK’s general election in May 2015 injects additional uncertainty, not least if it leads to a referendum on EU membership. Whichever political party wins in May must address the stubbornly large public-sector deficit.
Despite stronger-than-expected UK domestic activity in 2014, the growth in national income has not found its way to consumers. Corporate profits have picked up but employee pay has not. Although real wage growth will be positive in 2015, we expect it to remain slow and greater uncertainty will lead to slower consumption growth.
This uncertainty also means companies may sit on growing profits rather than invest, meaning business spending does not replace slowing growth in household consumption. Foreign direct investment may also fall if it is unclear whether the UK will remain a good base to access EU markets.
Diminishing slack in the labour market did not push up wage growth over 2013-2014 when unemployment was falling rapidly: as we expect employment growth to slow, it seems unlikely we will see rapid pay growth in 2015.
There have been some welcome signs of life in wages, including the first real-terms annual pay growth since 2009. Settlements in early 2015 will be key to assessing how these signs develop but, as yet, we are far from persuaded that we will see anything other than a gradual drift higher. Indeed, a 1 per cent cap on public-sector pay rises remains in place and will likely have to be extended if the incoming government is to meet deficit-reduction targets.
Wage demands may also stay low because falling inflation – and outright deflation in petrol and food – is boosting real incomes. We have revised down our forecasts and expect consumer-price inflation to bottom out in early 2015, possibly at just 0.9 per cent, before picking up towards the year end, partly because of sterling’s fall against the dollar.
This pick-up supports our expectation of a rate hike in the first quarter of 2016 but the slowing housing market also weakens the case for earlier rate rises. The Bank of England fears slowing the economy too quickly more than it worries about inflation taking off because, while it can tighten policy quickly, it can’t loosen much when interest rates are low.
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