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Bah! Humbug

We feel like Scrooge in A Christmas Carol but cannot help thinking that bah humbug will hit UK consumers next year. If there is a predictable surprise for the UK economy, it will be a sharp slowdown in economic growth due to squeezed incomes.

The consumer is a key driver of the UK economy. In the year to the third quarter of 2016, the economy grew by 2.3% and personal consumption accounted for 1.7 percentage points of that.

If consumption growth slows from its latest rate of 2.6% yoy, the whole economy will feel the chill wind. But how likely is a sharp slowdown? After all, retail sales grew a very healthy 5.9% yoy in November and a CBI survey of retailers showed sales at a 15-month high in December.

The crucial factor behind real expenditures is real incomes. The chart shows quarterly consumer spending growth (navy blue line) and a proxy for real incomes growth (grey). The proxy uses monthly data for average earnings, employment and consumer prices. While the fit is not perfect, one can see the relationship.


So we can break the consumer spending outlook down into earnings, jobs and prices. We reckon that incomes will grow by around 2.5% yoy in the fourth quarter – earnings growth of 2.6% plus employment growth of 1.1% minus inflation of 1.2%.

By this time next year, those numbers could be say 3.0% plus 0.5% minus 2.5% to give incomes growth of just 1.0%. Average earnings growth may pick up a little to reflect the tight labour market; jobs growth has been slowing for a while and may slow further, as Brexit fears intensify; and inflation is set to increase, partly due to sterling’s tumble since 23rd June and partly oil price rises.

Of course, Britons may dip into savings or borrow more in order to sustain spending. That has happened before! However, there are two good reasons to think households may be more cautious this time round.

First, Article 50 of the Lisbon Treaty could be triggered by 31st March. Even though actual departure from the EU may be many years hence, the start of divorce proceedings should prompt caution.

Second, memories of the 2008-09 financial crisis are relatively fresh. Many households suffered badly after the collapse of Lloyds and RBS. Once bitten, twice shy.

Elsewhere in the economy, we expect businesses also to be cautious so do not envisage a boost from investment spending. However, overseas trade should thrive, thanks to the pound’s more competitive level. The bottom line is that we expect annual average growth of 1 1/4% next year after 2.1% this year.

Investment Conclusion. This is tricky because so much in 2017 depends upon sentiment regarding Brexit and Trump. Leaving those aside, we expect the Bank of England to be on hold at worst during 2017 and would not rule out another easing later in the year. On a six to twelve month view, that will not benefit two year gilts much (today’s yield is just 7 bps!) but ten year yields could fall a bit; sterling will presumably weaken further; and this may give the internationally-exposed FTSE 100 some support but the domestically-focused FTSE 250 is likely to struggle.

Our investment strategy committee, which consists of seasoned strategists and investment managers, meets regularly to review asset allocation, geographical spread, sector preferences and key global market drivers and our economist produces research and views on global economies which complement this process.

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