Consumer spending will continue to outperform the economy as a whole despite being at its lowest level in six years, according to an EY ITEM Club special report. The EY ITEM Club forecasts consumer spending growth of 1.6% in 2019 and 1.7% in 2020, down from 1.8%, 2.2% and 3.2% in 2018, 2017 and 2016 respectively. The EY ITEM Club forecasts GDP to grow by 1.3% in 2019 and 1.5% in 2020.
According to the EY ITEM Club, in 2018 consumer spending benefitted from robust employment growth and a strong pick-up in real earnings growth over the second half of the year. Annual real earnings growth rose from 0.1% in mid-2018 to 1.5% at the end of 2018 and a peak of 1.6% in early 2019. Meanwhile, real household disposable income growth improved to 2.2% in 2018, from 0.5% in 2017 and a drop of 0.2% in 2016. However, EY ITEM Club says that the outlook for consumers is going to be relatively challenging over the next two years.Howard Archer, Chief Economic advisor to the EY ITEM Club, said “The improvement in purchasing power has meant that consumers have been significantly less affected in their spending decisions than businesses by uncertainties over the economy and Brexit. While consumer confidence in late 2018/early 2019 weakened to the lowest level since mid-2013, perceptions of personal finances and a willingness to spend generally held up much better than views of the economy.”

“However, we suspect earnings growth peaked in early 2019 and is likely to remain modestly below this level over the rest of 2019 and possibly beyond. We believe labour market strength will increasingly fray over the coming months as companies tailor their behaviour to a lacklustre domestic economy, prolonged Brexit uncertainties, an unsettled domestic political situation and a challenging global environment. As a result, we forecast employment growth to slow from 1.2% in 2018 to 1.0% in 2019 and 0.6% in 2020.”

Considering the significant role played by elevated consumer price inflation in dragging down real growth in incomes and spending in 2017 (especially) and part of 2018, 2019 should see a more benign picture overall which is largely expected to continue into 2020, says the EY ITEM Club.

The EY ITEM Club forecasts consumer price inflation to be at or just under 2% over the remainder of 2019, and it could fall to as low as 1.7% around August. Recent lower oil prices have helped the inflation outlook in the near term while domestic inflationary pressures are expected to be modest over the coming months amid likely lacklustre UK growth. Should the UK leave the EU with a deal at the end of October, the EY ITEM Club expects consumer price inflation to average 2.0% in 2020. Despite expected modestly stronger growth in 2020, an expected firmer pound will help to limit the rise in inflationary pressures while oil prices are forecast to be relatively weak overall.

The EY ITEM Club expects that employers will want to keep their labour costs as low as possible given the current uncertain economic outlook, recent poor productivity data, and rising costs from pensions auto-enrolment and the Apprenticeship Levy.

The EY ITEM Club forecasts annual earnings growth to average 3.2% over 2019, up from the 2018 outturn of 3.0% but down modestly from the late 2018/early 2019 peak rate of 3.5%. Overall inflation-adjusted pay is forecast to average 1.4% in 2019, up from 0.4% in 2017, but down from the early 2019 peak of 1.6%. The EY ITEM Club forecasts annual earnings growth to be stable at 3.2% over 2020, and overall inflation-adjusted pay is forecast to average 1.2%.

Howard Archer comments: “We expect real households’ disposable income growth to ease back to 1.6% in 2019 and 1.5% in 2020, having risen to 2.1% in 2018 from 0.5% in 2017 and 0.0% in 2016. Against a post-war average of 2.7% a year, this would be a soft performance. However, it would still be above the annual average rise of 1.2% recorded since the current economic expansion began in 2010.”

While the EY ITEM Club expects an improvement in spending power for the average household in 2019 and 2020, there are specific factors that could lead to significant differences across income groups.

Howard Archer said “Workers at either end of the income distribution should fare best over the next few years. Lower earners will see their spending power boosted by increases to the National Living Wage (NLW), a higher personal allowance income tax threshold and lower inflation in the food, petrol and energy categories. While those at the upper end will benefit from skills shortages which is likely to push up wages. The middle will remain squeezed, earning too much to benefit from the NLW, losing support from over-indexation of tax thresholds, and automation subduing their wages.”

Julie Carlyle, Partner and UK Head of Retail, EY said “Despite consumer spending comparing favourably to other parts of the economy, it is far weaker than it has been in previous years. Retailers are therefore fighting for a shrinking piece of the pie and this is reflected in the recent turbulence on British high streets. And, while the economy won’t deliver retailers growth, they will have to find it from other areas and this means having a strong understanding of their customers.”

“As technology advances and a high proportion of purchases become automated and executed by smart home systems, there will be a polarisation between buying and shopping. Retailers will need to put purpose at the heart of their strategy and offer customers a shopping experience that provides transparency, personalisation and connectivity. This will require substantial investment at a time when retailers’ margins are being squeezed, but it is essential for their survival.”