Growth in the UK economy has slowed since the summer as businesses have become more concerned about the lack of clarity around the consequences of Brexit. In our latest UK Economic Outlook, we have revised down our main scenario projection for GDP growth in 2019 to 1.1%, from 1.4% previously, as we now expect business investment to shrink in the year as a whole.
Since the EU referendum, it has primarily been consumer spending that has driven the economy. Higher inflation linked to the weaker pound did lead to a moderation in consumer spending growth in 2017, but it held up well in 2018 as inflation eased and earnings growth picked up. In the absence of any clear information on Brexit, consumers have generally maintained their existing spending habits. This means that spending growth has continued to outpace growth in incomes, resulting in a continuation of the long-term decline in the UK household savings ratio.
In 2019 we expect this trend to be briefly disrupted. First, we think that more acute Brexit uncertainty will result in a slowdown in consumer spending growth, especially in the first half of the year. Brexit has dominated the headlines so far this year to a much greater extent than it did in 2017-18. Combined with a softening of the housing market, this may reduce consumer confidence and the rate of spending growth.
Meanwhile, growth in household incomes is moving in the opposite direction as the labour market tightens, putting consistent upward pressure on wages. Nominal wages are rising at their fastest rate since before the global financial crisis and the rate is likely to continue to accelerate in 2019 (on the assumption that a disorderly Brexit is avoided). The combination of moderating spending growth and accelerating income growth will see the savings rate pick up this year.
In 2020 we expect a more typical outcome, with household spending growth returning to close to its trend rate and income growth continuing to accelerate. The net effect of these movements will be to push the savings rate up a little further, but this would reflect more the strength of the labour market than the parsimony of consumers.
What will consumers be spending their money on?
The next question to ask is that if consumer spending is to continue to grow, what are UK households going to be buying?
We have updated our long-term consumer spending model, which uses factors such as real income levels, relative price levels, demographics and income distribution to project how future spending could vary across the main categories. We expect that by 2030 households will spend more than 30% of their budget on housing and utilities, compared with around 27% at present. This is based on our assumption that supply shortages will keep house prices and rents rising relatively rapidly in real terms in the long run.
There will also be strong demand for miscellaneous services, such as financial services and personal care, so that this becomes the second-largest expenditure category by 2025. We expect the Bank of England to raise interest rates gradually, and insurance premiums, including tax, may also tend to increase.
Reflecting the UK’s status as a high-income economy, two leisure categories—recreation and culture and hotels and restaurants–are also relatively income-elastic. This means that their shares of household budgets tend to grow over time. By contrast, necessities such as food and clothing will tend to see their spending shares decline. These are also industries where prices have fallen owing to the development of highly efficient and sophisticated supply chains.
The rise and rise of online sales
Where consumers buy these goods and services from is also going to change in the coming years. Online sales accounted for more than 20% of total retail sales for the first time ever in November 2018, thanks to Black Friday promotions. But even without one-off events, the share accounted for by online is growing steadily.
To consider how far this trend could go, we mapped ONS data on the proportion of total sales that were made online for three of our consumer spending categories—food, clothing and furnishings—onto our projections of how these categories would perform until 2030. For food and furnishings we assumed that online sales would continue to grow at the same annual average pace as in recent years. For clothing, we believe the online market is more mature and therefore we have factored in a gradual moderation in growth in the 2020s.
Of the three categories, online sales accounted for the lowest proportion of total food sales in 2018 and growth has been slowest in this category. Consequently, we see the proportion of online food sales rising relatively modestly, from around 5.5% in 2018 to 8.5% by 2030. The short shelf-life of fresh food and consumers’ preference for picking their own groceries remain deterrents to online food shopping that will be challenging for retailers to overcome.
In the furnishings category, the move to online shopping has been more marked, with such sales accounting for just under 10% of the total in 2018. Our projections suggest that this could rise to around 22% by 2030. Bricks-and-mortar clothes retailers have seen the greatest disruption from online sales: around 18% of clothes were bought online in 2018, compared with 6% in 2010. If the current rates of growth continue, we project that online clothing sales could be almost one-third of total sales by 2030, at 32%.
These trends are already changing business strategy. Our survey of shop openings and closures showed that a net 1,123 stores closed in early 2018, up from 222 in the year-earlier period. The category that suffered the largest absolute fall in shops was clothes retailing, an outcome the analysis linked to the rise in online sales of fashion, although higher business rates since 2017 may also have been a factor here.
Interestingly, over the past five years, the number of new store openings across the retail sector has fallen by half while the number of closures has been relatively static. This suggests that firms have become much more cautious about investing in new bricks-and-mortar retail space, given the expanding role of online sales.
Were it not for politics, conditions would appear favourable for strong growth in household spending, given the record-breaking labour market and benign inflation. Instead, we think that uncertainty generated by Brexit, which has already had a demonstrable effect on business investment plans, is likely to act as a drag on consumer behaviour. However, on the assumption that a disorderly Brexit is avoided, this should prove a blip rather than a sustained shift, with a much more familiar pattern re-emerging in 2020.