Once again this year, the outcome of a vote, this time in the US, has surprised. Donald Trump is gradually announcing his plan for the first 100 days of his presidency, which features many of his policies from the campaign trail, such as withdrawing from the Trans-Pacific Partnership (TPP) trade agreement. However, in some cases President-elect Trump is now taking a materially different stance to candidate Trump, refining many of his key pledges (e.g. for Obamacare), leaving the world wondering about the policies he will actually pursue.
November saw the release of the latest Q3 GDP growth figures for most large economies. Eurozone growth lagged behind that of the US and UK. But this masks the strong performance of the periphery Eurozone countries, such as Spain and Cyprus, which continue to outperform the core countries of Germany, France and Italy.
The UK economy grew by 0.5% quarter-on-quarter, down on Q2 but still a respectable rate of growth showing little immediate impact from the Brexit vote. Looking to next year, however, against a backdrop of continued uncertainty regarding Brexit, the Office for Budget Responsibility (OBR) has downgraded its official projections for GDP growth from 2.2% to 1.4% for 2017. Against this weaker outlook, the Chancellor’s Autumn Statement focused on boosting productivity growth and investment, announcing measures to support infrastructure, housing and science and innovation.
The UK government also abandoned its aim to achieve a budget surplus by the end of this Parliament, choosing to follow the path of (modest) fiscal stimulus rather than continued austerity. We have seen other large economies—Canada, Japan, and the US—adopt this approach recently, taking advantage of low interest rates on offer to try to provide a long-term boost to productivity. We discuss why now is the right time to provide a fiscal boost, at least for countries with the necessary fiscal space.
As we approach Christmas, many consumer-focused businesses will be hoping for a bumper season of household spending. In this month’s GEW, we analyse the drivers of household spending and the implications for businesses in their revenue forecasting and planning. In the UK, gross disposable incomes are up and the savings ratio is down relative to this time last year, suggesting that this could be a promising Christmas period for European retail and consumer businesses, despite the Brexit vote.
PwC's Barret Kupelian discusses the implications of discretionary disposable income and savings for household spending in Europe this Christmas.
Growth in the Eurozone periphery continues to outperform that in the core
The latest GDP data revealed that the Eurozone economy grew by 0.3% in quarter-on-quarter terms in Q3 of this year, the same as in Q2. However, Eurozone growth was slower than in the US and the UK, where the economy grew by 0.8% and 0.5% respectively in Q3.
However, the overall Eurozone growth figure masks the strong performance of the peripheral Eurozone countries. Figure 2 shows that, in year-on-year terms, the periphery continued to perform better than the core, with growth of 2.8% year-on-year in Q3 compared to 1.4% year-on-year for the core economies. Spain and Cyprus, for example, are now amongst the fastest growing economies in the Eurozone.
Will political uncertainty cause the Eurozone’s steady recovery to falter?
Europe as a whole could be entering a period of intense political activity, which could lead to period of uncertainty. In early December Italians cast their vote in a referendum against proposals to streamline the legislative process, prompting Prime Minister Renzi to resign. This will be followed by Dutch elections in March 2017, French presidential election in April, and German federal elections in September (see Fig 1). The potential uncertainty surrounding these political events, as well as likely ongoing lack of clarity around future trading relationships between the UK and the European Union (EU) could dampen growth at least temporarily.
In our main scenario, however, we expect the Eurozone to continue growing at broadly trend rates of around 1.5% per annum in 2017. While the growth of the periphery may taper off a little next year, strong domestic demand is expected to support the economy in the core economies, as household incomes and spending continue to grow.
G7 growth is stable but anaemic
Growth in the advanced economies continues to be anaemic, despite record low interest rates: G7 GDP growth in the third quarter of this year averaged 1.4% on a year-on-year basis compared to a long term growth rate of slightly higher than 2% per annum.
Many policymakers are now re-focusing their attention on fiscal levers in a bid to stimulate growth. This year alone, we’ve seen most of the non-Eurozone large economies announce or extend fiscal plans:
These fiscal initiatives are likely to lead to a temporary worsening of budget balances, as Figure 3 shows, but also an increase in the contribution of government spending to growth.
Now is the right time to provide a fiscal boost
We have identified three key reasons why fiscal stimulus may be particularly beneficial in the present economic environment:
1. Current and future government debt can be financed at cheap rates
Since the financial crisis, most governments have taken steps to tackle the liability side of their balance sheet. Even though public debt levels remain relatively high by historic standards for some of the G7, the current weighted interest expense paid on government debt is at record lows. In the US, for example, the weighted average interest rate on its government debt is expected to be 1.8% this year, compared to 3.1% a decade ago.
Future funding costs should also continue to remain relatively low, even if they show some upward trend in response to this shift in fiscal policy. For example, yields on 10-year government bonds, a measure of the cost of borrowing, are considerably below their long-term (i.e. previous 20-year) averages for all of the G7 economies we have looked at. This is despite pronounced increases in the long-term bond yield curve following the US presidential election. Governments will, however, have to be sensitiveto any further large rise in their cost of borrowing in response to fiscal easing.
2. Policy complementarities can make fiscal policy more effective
While monetary policy has been expansionary in many advanced economies since the crisis, fiscal policy has been largely contractionary. According to the IMF, government deficits in the G7 have reduced by around 6 percentage points of GDP since 2009. But, using the two policies together will increase the likelihood of influencing aggregate demand.
Present low interest rates could actually increase the fiscal multiplier and therefore the direct impact of fiscal spending on GDP, as consumers and businesses find saving relatively less attractive.
3. Fiscal stimulus can directly deliver longer-term productivity benefits
Some policies associated with fiscal expansion can have a positive long-term impact on productivity. For example, efficient infrastructure investment can improve connectivity, while government support for R&D can result in technological advances that make workers more productive.
Monetary policy can also be used to try to boost productivity, but it relies on businesses taking advantage of the cheap funding on offer to spend on productivity enhancing investments instead of alternative options such as restructuring their debt or borrowing to build up inventories. Therefore, policymakers may prefer to use fiscal policy to target productivity growth more directly.
What are the main business opportunities?
Given the focus on infrastructure improvements across different economies, engineering and construction companies, in particular, could stand to benefit. Businesses in regions where these improvements are planned are also likely to gain, particularly over the longer-term. But if these plans can go some way towards raising productivity growth at a national level, then, over the longer-term, businesses across the economy stand to benefit.
Household spending is a key driver of economic performance
In many advanced economies, household spending is the largest component of GDP. The Christmas period is traditionally a time of significantly higher consumer spending and so is particularly important for European consumer-focused businesses. Across the European countries we monitor regularly, year-on-year gross disposable household income growth1 remains relatively strong so far this year at around 2%. But what does this suggest for household spending?
So which households are the biggest spenders in Europe?
The UK has the highest level of spending per household, leading the way by a considerable margin at around €59,000. Ireland ranks second at €49,000, followed by France at €41,000. In the UK, this strong household spending is a key driver of the economy, accounting for 65% of GDP, compared to 55% in France and Germany.
As discussed in a previous version of our UK Economic Outlook, household spending is determined by disposable income and changes to savings. The spending rankings are strongly correlated with disposable income rankings – the latest data shows the UK has the highest after-tax disposable income per household at around €61,000, followed by Ireland and France at 2015 exchange rates (though the recent weakness of the pound will have narrowed the gap in 2016). But our analysis shows a more nuanced definition of disposable income can tell a more informative story.
But what happens once ‘essential spending’ is accounted for?
Not all spending is the same. Spending on housing, food and transport are, in most cases, deemed essential for households in advanced economies. This means they are likely to be prioritised by households and also that they are less responsive to changes in price. Forecasting demand in sectors like utilities is therefore subject to less uncertainty.
What really matters for households and businesses is how much of household income is left over for spending on ‘non-essentials’ such as alcohol, eating out, holidays and entertainment. Adjusting for spending on ‘essentials’2 we estimated discretionary disposable income per household. Below we list out our key findings:
High household savings can have positive consequences for businesses
The other main driver of household spending is the savings ratio3. Figure 5 shows that Germany has the highest savings ratio of the EU countries we analysed, with the UK and Ireland sitting towards the bottom of the list. A high savings ratio can put downward pressure on spending, and therefore revenues. However, it can also be good news for businesses, as it allows households to sustain spending during an economic downturn. Figure 6 shows that the economies which had a relatively high savings ratio in the run up to the financial crisis in 2009 made relatively smaller cut-backs in household spending during the crisis. In these countries, high savings can also increase private investment, boosting productivity.
What does all this mean for businesses this Christmas period?
Disposable household income is an important variable for providers of non-essential products when projecting revenues. But, as our analysis shows, taking a more nuanced measure of discretionary disposable income can tell a slightly different story. Changes in the savings ratio also have considerable implications for future spending meaning businesses should complement their forecasting with these additional measures. Last year, discretionary disposable incomes grew for the first time since the crisis, suggesting real household spending power has only just started to recover. Combined with the fact that adjusted savings ratios are either falling or remaining stable in all 9 countries except for the Netherlands, this suggests the Christmas period could be a prosperous one for many businesses across Europe. Santa’s elves may have a busy December ahead.
1Deflated using the implicit household consumption deflator
2Essentials: Housing, water, electricity and gas; food and non-alcoholic beverages; transport; health; and education
Non-essentials: Alcohol and tobacco; clothing and footwear; restaurants and hotels; recreation and culture; communications; furnishings and household equipment; and miscellaneous goods and services
3Calculated as the difference between household disposable income and spending, as a proportion of disposable income.