The U.K. Economy's Dependable Engine May Lose Some Pep in 2016

Cameron's EU Reform Gains Momentum
  • Domestic demand has driven Britain's post-crisis economy
  • Inflation is set to pick up to 1.3% by the end of next year

The strongest pillar of the U.K. economy may start to wobble in 2016.

Having boosted growth for nine straight quarters, consumer spending could be up against restraints next year that will curb its momentum. For now, the shopping party continues, with data on Thursday showing annual retail sales growth exceeding 5 percent in the past three months.

A pickup in inflation, albeit gentle, anticipation of a Bank of England interest-rate increase and a continued fiscal tightening by Chancellor of the Exchequer George Osborne could put a squeeze on households through next year. While a cooler spending pace won’t spell the end of the economy’s growth streak, it will increase the burden on trade, which has detracted from growth so far this year.

“Household spending will continue to do quite well next year, though real income growth will ease a bit as welfare measures kick in and as inflation rebounds,” said Samuel Tombs, an economist at Pantheon Macroeconomics in London. “That will subdue growth in households’ real incomes, which has been really strong this year.”

Price Benefits

Consumers have benefited from a supermarket price war, which has seen the U.K.’s biggest chains battle for sales. Britons have also enjoyed the strongest real-income growth since before the financial crisis as lower oil prices pushed inflation to a record low and wages strengthened.

That’s been a boon for the economy, with expansion of 2.4 percent forecast for 2015. Growth may cool to 2.3 percent and 2.2 percent in the next two years, according to a Bloomberg survey of economists. A third estimate of GDP published Wednesday is expected to confirm the economy grew at 0.5 percent in the third quarter and will provide details on the saving ratio and disposable income.

The backdrop may shift in 2016. One big unknown is Britain’s planned vote on European Union membership. That could take place next year and has the potential to shake confidence. An online poll released on Thursday found that 47 percent of voters favor leaving the EU -- a so-called Brexit -- and 38 percent want to stay, though that’s at odds with two telephone polls published the day before that showed leads of as much as 21 percentage points for the pro-EU camp.

As inflation edges up -- it’s forecast to hit 1.7 percent by the end of 2016 -- that will nudge the Bank of England closer to its first rate increase in more than eight years. The bank’s Financial Policy Committee has also signaled it’s ready to put brakes on parts of the property market it it sees risks building.

Debt Concerns

The benchmark rate has been at a record-low 0.5 percent since early 2009, though the BOE says that Britons have improved their finances over the past year and are in a better position financially to deal with policy tightening. Nevertheless, unsecured debt such as credit-card borrowing is growing at the fastest annual pace in a decade.

Much of households’ capacity to cope depends on wage growth. While payrolls are rising and the unemployment rate is at the lowest in more than seven years, earnings growth has weakened, leaving Governor Mark Carney and fellow BOE officials with difficulties in decoding the labor market.

“Even as inflation begins to rise in the second half of next year, you’ve probably got nominal wage growth picking up,” said Simon Wells, an economist at HSBC in London. “So real incomes, which have supported a huge amount of the domestic expansion we’ve seen, should continue to grow.”

Bad Mix

Without an accompanying pickup in other parts of the economy, strong domestic demand will exacerbate the U.K.’s unbalanced mix of growth. Surveys point to continued weak exports and net trade had a record drag on GDP in the third quarter.

Domestic spending will continue to fuel growth at a slower pace in 2016 and that is “far from being a guarantee for success,” said Sarah Boumphrey, head of economic and consumer insight at Euromonitor International. “The export performance is weak with an over-reliance on a small number of trade partners, leaving it vulnerable to external shocks.”

That was echoed by the British Chambers of Commerce in its response to the stronger-than-forecast retail data on Thursday, which showed a monthly sales gain of 1.7 percent.

It “highlights the unbalanced nature of our recovery,” said David Kern, chief economist at the group. “While strong consumer spending and services remain vital to our economy, it is important to achieve greater balance.”

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