Are you ready for life after the consumer boom?

Make hay while the sun shines…

Consumer spending grew at the fastest rate since the financial crisis in 2015, significantly outperforming the projections set out in the 2014 EY ITEM Club Consumer Spending report. Low inflation and falling oil and commodity prices were the key drivers of faster than expected spending growth.

The outlook for 2016 is similarly strong with low inflation, delays to any rise in interest rates, strong consumer confidence and the introduction of the National Living Wage  (NLW) all boosting the prospects for consumers. The EY ITEM Club expects consumer spending growth of 2.9% in 2016, in line with the out-turn for 2015.

…expect  a tougher environment…

But that is where the good news ends. After 2016, a number of factors such as rises in interest rates, the return of inflation, the introduction of Universal Credit, increased costs of employment such as the Apprenticeship Levy and strong labour supply growth could all impact household incomes adversely.

The two changes most likely to improve consumer prospects after 2016 are the introduction of the NLW and the continuing guarantees of pensioner incomes.

• The NLW will primarily boost incomes at the lower end of the income distribution but across households its impact will be more evenly spread as many low paid workers are the second earners in relatively affluent households. A lower marginal propensity to consume in higher income households and tax and benefit impacts that limit the forecast benefit of the NLW to income incomes to 60% of the NLW amount mean the impact will be less than absolute numbers would imply.
• Pensioners will continue to benefit from the “triple lock” and this together will higher numbers of older people in work, close to double the 2008 level currently, both incomes and spending of older groups will continue to grow faster than average.

With the expectation that interest rates will remain low for some time, house price appreciation is further likely to boost consumer wealth and hence spending, while higher debt payments will not have a significant impact on disposable incomes for some time. For example, Bank of England surveys suggest only 31% of mortgage holders  would need to reduce their spending in response to a 2% rise in interest rates, down from 44% in 2013.

These changes will be more than offset by a number of factors that will have a negative drag on the growth of consumer incomes:

• The introduction of Universal Credit from 2017 will mean that reductions in incomes will amount to around 90% of the impact of the abandoned tax credits by 2020;
• Additional costs on employers such as the Apprenticeship Levy and pensions are most likely to be recovered by employers through lower wages; and
• Higher inflation and interest rates will squeeze consumer incomes.

The most significant influence on future consumer prosperity will be the rate of wage rises. The UK has witnessed unprecedented rates of growth in employment and today unemployment is at very low levels, around 5.1% as at November 2015, and the participation rate is at an all-time high of 74%. But this has not been matched by a corresponding rise in wages, quite the opposite in fact. After showing signs of accelerating, with the average growth in average weekly earnings reaching 3.3% in May 2015, recent data points to a cooling off with the rate falling to 2% by the end of 2015.

Many theories have been advanced for the fall in the rate of wage inflation. Weak trades unions, shifts in the sector mix of employment, and a strong growth in labour supply, as a result of record numbers of older workers and continuing high levels of immigration, have all played a part. There is now anecdotal evidence that low price rises are impacting employers’ decisions on the level of pay rises, further reducing pay settlements.

EY ITEM Club expects that consumer spending growth will slow to 2.1% in 2017, down from 2.9% in 2016 and then average just 1.9% annually between 2017 and 2019. While lower income groups and older people are expected to increase their spending faster than average, the overall picture is of relatively slow growth.

…and plan accordingly.

Consumer facing businesses are likely to have the luxury of a year to 18 months to position their operations for a slower growth in consumer spending. This year is the ideal time to:

• Review future growth forecasts at the segment and product level and ensure these are consistent with expected economic conditions;
• Ensure the opportunities in relatively faster growth segments, such as older customers and lower income groups, are fully reflected;
• Consider how realistic pricing plans are in the light of a low inflation, low income growth environment;
• Analyse capital expenditure proposals for the scope to drive additional efficiency gains, possibly via labour saving investment to limit exposure to the NLW.

@MarkGregoryEY

markgregoryeconomics.ey.com

EY Economics for Business provides knowledge, analysis and insight to help business leaders understand the economic environments in which they operate, both in the UK and globally.