Low inflation, due to falling commodity prices, combined with the Chancellor’s decision to delay his changes to tax credits, will extend the good times for UK consumers into this year, according to the EY ITEM Club’s Winter Forecast.
The EY ITEM Club expects consumer spending to increase by 2.8 per cent in 2016, which will help push GDP growth up to 2.6 per cent, from last year’s downward revised 2.2 per cent.
However, as austerity bites harder and inflation picks up in 2017, they will bear down on consumer spending growth, which is forecast to slow to 2.1 per cent in 2017 and 1.7 per cent in 2018. This will cool the UK’s GDP growth rate to 2.3 per cent and 2.2 per cent respectively.
Inflation is forecast to average only 0.4 per cent in the first quarter of 2016 and is not expected to reach the key one per cent benchmark until the final quarter.
According to the forecast, inflation is likely to remain below the MPC’s two per cent target for a prolonged period, averaging 1.6 per cent in 2017 and 1.8 per cent in 2018.
The EY ITEM Club says that it will be difficult for the MPC to justify an increase in interest rates while inflation remains so low and does not expect the first rate rise until the autumn, at the earliest.
Peter Spencer, chief economic adviser to the EY ITEM Club said: “The UK consumer had a welcome holiday from inflation and austerity in 2015, and, until recently, this had look set to come to an end. However, the combination of further falls in commodity prices and the money that the Chancellor found behind the sofa for his Autumn Statement ‘giveaways’, mean that this holiday will be extended into this year.
“But every holiday must come to an end. Inflation will start to pick up towards the end of 2016, while the impact of the government’s welfare savings will increasingly be felt. This will eat into spending power and cause consumer spending growth to slow.”
Mark Gregory, EY’s chief economist adds: “The consumer led recovery will continue this year, but UK businesses have to start preparing for life after 2016. Businesses should be considering how to use capital investment to reshape their business models .”