Contents
EY is the sole sponsor of
the ITEM Club, which is the
only non-governmental
economic forecasting
group to use the HM
Treasury model of the UK
economy. Its forecasts are
independent of any
political, economic or
business bias.
Foreword
2
Highlights
3
Recent trends in consumer spending
5
The outlook for household incomes
6
The outlook for different household groups
10
Non-income drivers of consumer spending
14
Forecasts for consumer spending
17
Conclusion
20
Appendix — consumer spending categories
21
EY  1
Foreword
Foreword
Mark Gregory
EY Chief Economist UKI
@MarkGregoryEY
► Driven by low inflation and falling oil and commodity prices, UK
consumer spending in 2015 grew at its fastest rate since the
financial crisis. The outlook for 2016 is similarly strong, boosted by
low inflation, continued record-low interest rates, strong consumer
confidence and the introduction of the National Living Wage (NLW).
As a result, the EY ITEM Club expects UK consumer spending to
grow by 2.9% in 2016, in line with the outturn for 2015.
► During 2016, the effects the NLW — boosting the incomes of around
six million workers — will be compounded by renewed falls in oil
prices and recent cuts in energy bills. As a result, inflation will
struggle to reach even 1% by year-end, helping real incomes to
grow. Meanwhile, continued low interest rates will support higher
house prices, in turn boosting consumers’ wealth and spending.
► However, beyond 2016, consumers are set for a tougher time.
Higher inflation and interest rates will squeeze household incomes,
while cuts to welfare will hit low earners. And employers may
choose to pass on the costs of the NLW and the Apprenticeship Levy
to workers via lower pay growth and reduced headcounts,
respectively.
► Given these factors, EY ITEM expects that consumer spending
growth will slow down from 2.9% in 2016 to 2.1% in 2017, and will
average just 1.9% annually between 2017 and 2019. While lowerincome groups and older people are expected to increase their
spending faster than average, the incomes and spending of middleincome households are set to remain relatively squeezed.
► With changes in incomes differing by age and income segment, the
prospects for market growth vary markedly between different
categories of goods and services, with an ageing population
favouring some sectors over others. However the overall recovery in
discretionary spending seen last year, supported by growth in real
incomes, should continue through 2016 and beyond.
► With the UK consumer marketplace projected to slow and evolve in
the next few years, 2016 is the ideal time for businesses to: review
growth forecasts at the segment and product level, and ensure
these are consistent with expected economic conditions; identify
and reflect opportunities in relatively faster-growing segments such
as older customers and lower income groups; consider how realistic
current pricing plans are in the light of a low-inflation, low income
growth environment; and analyse capital expenditure plans for the
scope to drive additional efficiency gains, possibly via labour-saving
investments to limit exposure to the NLW.
EY  2
Highlights
Highlights
►
The consumer holiday is set to continue this year, with very low inflation and the National Living Wage
supporting households’ spending power. But beyond 2016, as inflation sees a more meaningful pick up
and fiscal austerity bites, growth in both real household incomes and spending is predicted to slow to
rates more in line with the post-crisis norm. So “make hay while the sun shines” would seem an
appropriate message for consumers to take to heart.
►
2015 saw growth in real household incomes and consumer spending both reach post-financial crisis
highs, reflecting in part a remarkably benign backdrop of ultra-low inflation. In that respect, the strong
consumer performance was an unusual one, more apparent in real than in nominal terms.
►
2016 will see broadly more of the same, with the various tailwinds supporting consumption suggesting
that annual growth in real spending will match 2015’s 2.9% pace. A tighter labour market should beget
some upturn in pay growth, with the low-paid supported by the introduction of the National Living Wage
(NLW). Furthermore, interest rates are set to stay low for a further prolonged period, spurring credit
growth, consumer confidence remains elevated and households’ balance sheets are in their strongest
position since the financial crisis struck.
►
That said, good luck in the form of very low inflation will continue to play a major role in supporting
growth in consumption — the annual CPI measure is expected to struggle to reach 1% even by the end of
2016. Depressed energy and food prices will keep inflation down, boosting households’ discretionary
spending power, particularly for those on low incomes.
►
But a lack of inflation will disguise some less consumer-friendly developments. While a tighter labour
market should bring forth an uptick in pay rises, growth in earnings will continue to be held back by
structural changes in the UK labour market. Welfare reform and a more flexible labour market appear to
have contributed to falling unemployment exerting less upward pressure on pay than was the case in the
past. And ‘lowflation’ risks exacerbating this development by weighing on wage settlements.
►
Granted, April’s NLW will boost the pay of around 6m workers. But it is by no means a free lunch. Part of
the gain to individuals will be lost in higher tax payments and withdrawn benefits. And to the extent that
the NLW causes employers to cut headcounts or hours worked, this will mitigate the benefit to incomes
and spending. What’s more, a sizable proportion of the gains from the NLW are estimated to accrue to
households in the top half of the income distribution. Since the propensity to consume extra income
tends to decline as pay rises, this will dampen the effect of the higher wage floor on spending.
►
Meanwhile, if recent falls in equity prices persist, the effect on household wealth may encourage some
retrenchment. And although the Chancellor chose to backtrack on cuts to tax credits due to take effect
this April, this was less a reprieve and more a stay of execution. Other welfare savings will still take
effect this year and the planned cuts to tax credits will bite in later years as universal credit is rolled out.
And to the extent that employers pass much of the cost of the apprenticeship levy, due to be
implemented in 2017, onto workers in the form of lower wages, this will represent another drag on
income growth.
►
Among different types of consumers, one group that is set to see its income climb relative to the
average is elderly people, thanks to growth in the number of older workers and the backstop provided by
the generosity of the pensions “triple-lock”. This in turn will have implications for consumer spending by
sector, with areas like health-related products and home maintenance likely to benefit, but clothing sales
losing out. The broader trend of a continued recovery in overall household incomes points to a further
rebound in most areas of discretionary spending this year, but a softer pace of growth from 2017-20 as
rises in incomes slacken off.
EY  3
EY ITEM Club special report on consumer spending
EY ITEM Club special report on
consumer spending
Our last Special Report on consumer spending was published back in September 2014. 1 That report set
out an optimistic picture of prospects for the consumer sector, predicting a reasonable, if fairly modest,
pace of growth in consumer spending in 2015 and beyond.
What we didn’t foresee 18 months ago was the collapse in the price of oil and other commodities which
occurred at the end of 2014, a development which has been repeated on a smaller scale in recent
months. The consequence has been inflation falling to historically low levels, providing a sizeable fillip to
growth in real household incomes and spending. What’s more, consumers proved to be less prudent than
the 2014 Report anticipated, with 2015 likely to have seen the household saving ratio fall to the lowest
level since records began more than half a century ago.
But what can we expect for consumer spending in 2016 and beyond? This Special Report looks at the
recent strong performance of private consumption, an unusual consumer resurgence that has been
much more evident in real than cash terms. We then assess future prospects for household incomes,
including the forthcoming introduction of the National Living Wage. This in turn feeds into an analysis of
how different household groups are set to fare over the next few years, before considering likely
developments in non-income drivers of consumer spending. The report concludes by examining
prospects for different categories of consumer spending.
1
EY ITEM Club “Special report on the outlook for consumer spending”, September 2014,
http://www.ey.com/Publication/vwLUAssets/EY-ITEM-Club-Special-Report-on-Consumer-Spending-September-2014-fullreport/$FILE/EY-ITEM-Club-Special-Report-on-Consumer-Spending-September-2014-full-report.pdf
EY  4
EY ITEM Club special report on consumer spending
Recent trends in consumer spending
Notwithstanding a run of sustained economic growth since the end of 2009, the UK economy has been
far from fitting any description of a “boom” in recent years. GDP growth during the current expansion
has fallen short of the economy’s long-run average and output has made little headway in eroding the
shortfall that has developed relative to the level implied by the pre-crisis trend. And in terms of what has
driven this fairly unspectacular performance, the consumer has by no means played a stand out role.
For example, taking the first quarter of 2008 as a starting point, as of Q4 2015, consumer spending (up
5.3%) had actually grown by less in real terms than overall GDP (a rise of 6.7%). In fact, among the
expenditure components of GDP, consumer spending has trailed behind government consumption and
business investment in terms of relative progress made since the beginning of 2008. Moreover, since the
economy embarked on its current expansion in Q3 2009, total output has recorded average quarterly
growth of 0.5%. But the rise in consumer spending has averaged a more modest 0.4%.
However, the more recent performance of consumer spending has been undeniably impressive. 2015
saw real growth of 2.9%, the fastest since 2007 and a rate which placed 2015 as the first year to see
consumption outpace growth in overall GDP since 2012. What’s more, a rise in retail sales volumes of
4.5% was the best performance since 2004. And on the non-retail side, new car registrations reached a
record high of 2.6m in 2015, up from 2011’s post-recession trough of 1.9m.
In accounting for 2015’s strength, the boost delivered to shoppers’ purchasing power from last year’s
absence of inflation shouldn’t be underestimated. Indeed, disinflationary pressures in the retail and
broader consumer sector mean that the performance of consumer spending by value presents a very
different picture from the inflation-adjusted numbers. In cash terms, consumer spending grew by just
over 3% in 2015, a marked slowdown on the 4.3% recorded the previous year and the weakest rise since
2009. And on the retail side, sales values were up by a modest 1.1% in 2015, also a six-year low.
EY  5
EY ITEM Club special report on consumer spending
The outlook for household incomes
Growth in real incomes will continue to be bolstered by low inflation
Real household incomes are estimated to have risen by 3.4% in 2015, the biggest gain since 2001 and a
major improvement on the 0.6% increase seen in 2014. Although growth in cash incomes was
unspectacular, real growth received a significant boost from a year of ‘noflation’ — annual CPI inflation
averaged precisely zero in 2015, the first year to see this since 1934.
2016 is set to see inflation rise but the increase will be very gradual. Reflecting renewed fall in oil prices,
cuts in energy bills and disinflation across much of the consumer spending basket, CPI inflation is
forecast to reach only around ½% by the middle of 2016 and end the year at 1%, still only halfway to the
Monetary Policy Committee’s (MPC’s) 2% inflation target. So the drag on real incomes from rising prices
is set to remain well below the long-run norm (CPI inflation averaged almost 3% from 2008-2014), albeit
following a year where there was no drag from this source at all.
Where there is more uncertainty is over what will happen to growth in cash incomes. In theory, a tighter
jobs market should support stronger pay growth. Labour force data for the last quarter of 2015 showed
the LFS unemployment rate at 5.1%, the lowest rate in a decade, while the employment rate increased to
a record high of 74.1%. What’s more, with job vacancies also reaching an historic high, the number of
unemployed people per vacancy fell to 2.2, below the 2003–07 average. And we expect the
unemployment rate to drop further, albeit modestly given a further recovery in labour productivity, the
incentive provided by more expensive workers and cheaper energy to invest in labour-saving capital
equipment and another year of strong growth in the supply of workers.
Falling joblessness is delivering less of an uptick in pay…
It would be natural to expect lower joblessness to push up pay growth as firms compete for a shrinking
pool of unemployed workers. But recent data suggests that the spur to pay growth from lower
unemployment is proving to be underwhelming. The first half of 2015 had seen the jobs market return
to the more ‘normal’ pattern seen during previous economic recoveries, with the demand for workers
outstripping supply and exerting upward pressure on pay growth. Indeed on a headline (three-month
average) basis, annual growth in average weekly earnings reached 3.3% in May 2015, having averaged
only 1.4% from 2009 to 2014. But despite unemployment continuing to fall since then, the pace of
expansion in average pay levels has decelerated, with headline pay growth falling to 2% at the end of
2015. Consequently, while the unemployment rate in late-2015 was back to the average observed from
2001-2007, annual pay growth was only half the 4% recorded over that pre-financial crisis period. So
the so-called ‘Phillips Curve’, which posits an inverse relationship between unemployment and pay
growth, seems to have shifted down.
EY  6
EY ITEM Club special report on consumer spending
Compositional effects in the form of a shift towards lower-skilled and lower paid jobs may explain part of
this development. Indeed, analysis in the Bank of England’s February 2016 Inflation Report suggests
that these effects are currently reducing annual growth in the average weekly earnings measure by
around 1%.2 But a number of more structural explanations have been mooted as to why falling
joblessness has failed to trigger a sustained pick-up in pay.3 An increasingly flexible labour market,
evidenced by the rise in part-time and self-employment in recent years, and a tightening up of eligibility
criteria for out of work benefits are two. The latter is well illustrated by the dramatic decline in the
proportion of people officially classed by the Labour Force Survey as ‘unemployed’ who are also in
receipt of Jobseeker’s Allowance (JSA). In the 1990s, around 90% of the total pool of unemployed
received JSA or its pre-1996 equivalent. But that share had fallen to only 47% as of the end of 2015.
Consequently, financial pressure on the unemployed to find work is much greater, implying that a given
level of joblessness exerts more downward pressure on pay.
A drop in inflation expectations among employers and workers is a third possibility. December’s Bank of
England’s Agents’ survey pointed to low inflation feeding into subdued pay claims, supporting a
hypothesis that had been raised by the Bank’s Monetary Policy Committee (MPC) in the minutes of
recent Committee meetings. This poses the risk of a negative feedback loop developing, where very low
inflation weighs on pay settlements, which in turn weakens consumer demand and, correspondingly,
domestically-generated inflation. In a world where firms find it very difficult to increase revenue by
raising prices, there is less money available for pay rises and pay growth is depressed further.
Granted, this effect should fade as inflation picks up (although the predicted slow pace of the rise risks
embedding expectations of very low inflation among employers and workers). And we still think that a
tighter labour market will make its presence felt in terms of a further gradual improvement in cash pay
growth. But the downward shift in the association between unemployment and pay rises is another
reason to maintain our long-held view that the 4½-5% annual growth in average earnings typical before
the financial crisis is unlikely to return in the next few years. Meanwhile, a buoyant supply of labour,
driven by immigration, late retirement, welfare reform and other powerful factors, will continue to
challenge the jobs market in avoiding the dynamic of an employment-rich/wage-weak expansion that
characterised the early part of the recovery.
…while gain from ‘National Living Wage’ will be a qualified one
That said, against the drag on incomes from an
environment where pay is less responsive to falling
unemployment, two policy measures should, on the
face of it, provide some offset. The first is the
‘National Living Wage’ (NLW) which the
Government announced in July 2015 for workers
aged 25 and older. The NLW will take effect from
April 2016 at a rate of £7.20 per hour (compared
to the current NLW of £6.70), with a target to
reach 60% of median hourly earnings by 2020
(around £9.35 on current projections). The Office
for Budget Responsibility (OBR) estimates that
¾ million employees otherwise earning the NMW
will on average see an increase in weekly pay of
£28. Around 2 million people moving from above
the NMW to at least the NLW will gain £15 a week
on average. The OBR also anticipates a more
2
See Chapter 3 of the Bank of England’s February 2016 “Inflation Report”.
http://www.bankofengland.co.uk/publications/Documents/inflationreport/2016/feb.pdf
3
This issue was discussed by the Governor of the Bank of England, Mark Carney, in his speech “The turn of the year”, Peston
Lecture, Queen Mary University of London, 19 January 2016.
http://www.bankofengland.co.uk/publications/Documents/speeches/2016/speech873.pdf
EY  7
EY ITEM Club special report on consumer spending
modest wage ‘spillover’ for employees earning above the NMW, as firms seek to maintain pay
differentials, affecting 3¼ million people. In aggregate, the NLW is expected to boost the UK’s total wage
bill by £3¼bn by 2020, or around 0.3% of total employee compensation.4
However, that the NLW will boost disposable incomes and consumer spending to a similar extent is not as
obvious as may initially appear. First of all, for those workers gaining from the NLW, a proportion of the
increase in earnings will be lost in higher tax payments and lower benefit entitlements. The Institute for
Fiscal Studies (IFS) has estimated that just over 60% of the increase in gross wages arising from the NLW
will feed through to an increase in net incomes.5 Second, the NLW will have a dampening effect on pay
growth (and consumer spending) to the extent that it raises unemployment, causes employers to cut
employee hours and/or reduces the economy’s sustainable rate of growth. Modelling by the OBR
suggests that a drag from these sources will be real, if fairly modest. The official forecaster estimates
that joblessness will ultimately be around 0.2
percentage points or 60,000 higher, average hours
UK: Average earnings & inflation
worked 0.2% lower and real GDP lower by 0.1% than
% year
in the absence of the NLW. While these effects are
7
Average earnings*
small, the implication is still that the NLW will lower
Forecast
CPI inflation
6
living standards and household resources. By the
5
same token, even if the NLW has no effect on
employment, hours or GDP, its cost will still have to
4
be borne somewhere, whether in the form of lower
3
company profits, depressing returns to shareholders,
2
or higher prices, to the detriment of consumers.
1
But for the low-paid in work, the NLW will have a
positive effect (explored in more detail in the following
Section). This will contribute to average weekly
earnings rising by a forecast 3.4% this year, up on the
2.8% estimated in 2015, before maintaining a similar
pace over the subsequent three years.
0
-1
-2
2004
2006
2008
Source : EY ITEM Club
2010
2012
2014
2016
2018
2020
*National Accounts measure
The delay to welfare cuts is a drag averted
A less ambiguous boost to post-tax incomes will
come from an above-inflation increase in the
income tax personal allowance in the next two
fiscal years. The allowance is set to rise from
£10,600 to £10,800 this April and then to
£11,000 in April 2017, providing an annual £80
gain to workers earning above the current
threshold. And the higher-rate threshold will see
also see an increase, from £42,385 to £42,700 in
April 2016 and then to £43,000 a year later.
Overall, these two measures will boost household
incomes by around £2.9bn per year by 2017-18.
And while we do not make allowance for it in our
forecasts, given that it is not official policy, it is
quite possible that these above-inflation increases
will continue in later years, if the government is to
achieve its election manifesto commitment to
4
See Box 3.2 of the November 2015 OBR “Economic and Fiscal Outlook”.
http://budgetresponsibility.org.uk/docs/dlm_uploads/EFO_November__2015.pdf
5
Institute for Fiscal Studies (2015) “An assessment of the potential compensation provided by the new ‘National Living Wage’ for
the personal tax and benefit measures announced for implementation in the current parliament”, IFS Briefing Note BN175.
http://www.ifs.org.uk/uploads/publications/bns/BN175.pdf
EY  8
EY ITEM Club special report on consumer spending
increase the personal allowance to £12,500 and the higher rate threshold to £50,000 by the end of
the current Parliament.
Under the plans set out by the Government in the July 2015 Budget, the support to incomes from the
NLW and more generous tax allowances would have been offset by cuts to welfare spending that were
due to take effect this April. However, November 2015’s Autumn Statement saw the Chancellor choose
to defer some elements of the cuts (a reduction in the income level at which tax credits begin to be
withdrawn and a rise in the rate of withdrawal), so avoiding a £3.4 billion reduction in payments to
affected lower-income households in 2016-17. But this is less a reprieve and more a stay of execution
for affected families. The cuts will still apply to universal credit, so as the new benefit is rolled out across
the country, an increasing proportion of households in receipt of working-age benefits will see
reductions in income from the state. Indeed, almost 90% of the £3.4bn saving forgone by the Exchequer
in 2016-17 will have been recovered by the end of the decade. And other elements of Mr Osborne’s
planned squeeze on welfare spending, including a four-year cash freeze in working-age benefits and a
reduction in the welfare cap, will still take effect this April. All in all, the aggregate effect of these
measures remains on course to reduce household incomes by £12bn by the end of the decade.
Another Government action is also likely to weigh on income growth from next year onwards. The
‘apprenticeship levy’ will come into effect in 2017-18, raising around £3bn per year from employers to
fund apprenticeships. The OBR’s assumption is that firms will choose to pass most of the cost of this new
tax onto workers, implying a cumulative reduction in average earnings of around 0.3 per cent by 202021 (almost exactly offsetting the effect of the NLW). But there will be some mitigation via the
postponement of planned increases in auto-enrolment pension contributions, which will reduce employer
costs slightly in 2017-18 and 2018-19.
So the effect of policy measures on household incomes is more mixed than a cursory look might suggest.
However, the positives of a strong labour market and continued very low inflation shouldn’t be
underplayed. Overall, an assessment of the various forces acting on household income growth leads us
to expect a rise in real terms of 3% in 2016. While this would be slower than the 3.4% increase achieved
last year, 2015’s rise was exceptional (the strongest since 2001), with ‘noflation’ delivering a highly
unusual level of support. Moreover, growth of 3% would be well above the 2.1% averaged from 2003 to
2007, implying that, at least on this metric, the economy is making up lost ground. But as inflation picks
up further and fiscal austerity starts to bite, 2017 and beyond will see real income growth slow. Our
forecast shows real income growth averaging just 1.6% a year from 2017-20.
EY  9
EY ITEM Club special report on consumer spending
The outlook for different household
groups
Low earners will gain disproportionately from modest inflation…
Against a fairly healthy outlook for overall household incomes, how do prospects appear at a more
disaggregated level? Two ways of breaking down households are on the basis of income and of age.
Looking at the population by income, those forces set to keep inflation low offer reason to think that
low-earners should continue to enjoy an improvement in living standards relative to their higher-income
peers. Notably, since food and energy account for a larger share of spending by the lower paid, the
recent drop in oil and commodity prices will provide a disproportionate boost to this part of the
population. As of the start of February, UK petrol prices had dropped by 13% on the level six months
earlier. And all the ‘big six’ energy companies have recently announced cuts in gas bills which will take
effect in early-2016. Expenditure on food, energy and petrol accounts for over almost a quarter of total
expenditure by households in the bottom two income deciles. But the share for the richest two deciles is
10 percentage points lower. And since the appetite to consume extra income is likely to rise as we move
down the income spectrum, that households in this category are set to continue enjoying
disproportionate real income gains is good news for spending growth.
…and the National Living Wage
Meanwhile, individuals in the lower income deciles will also gain from April’s rise in the tax-free personal
allowance and, further ahead, the Government’s commitment to raise the allowance to £12,500 by the
end of the decade. But the already high level of the tax-free threshold means that those on very low
incomes will not benefit from the rise, something that will become more marked as the threshold
continues to climb.
However, the introduction of the NLW should complement low inflation in providing a disproportionate
boost to the spending power of those at the lower end of the pay scale. Indeed, we expect take-home
pay in for the bottom fifth of the income distribution to rise by 5% this year, compared to growth of just
over 2% for workers in the top two income deciles. The gap in terms of real take-home pay is even wider,
reflecting the relative boon to low earners from cheaper essentials.
EY  10
EY ITEM Club special report on consumer spending
Take-home pay
Annual % change
Income percentiles
10
20
30
40
Median
60
70
80
90
1997-2007
4.0
3.8
3.7
3.7
3.7
3.8
3.8
3.9
4.1
2008
4.6
3.6
4.1
4.5
5.1
5.6
5.9
6.2
3.4
2009
3.9
3.7
3.2
3.2
2.9
2.7
2.7
2.4
3.4
2010
-2.2
-1.2
-0.6
-0.2
-0.4
-0.1
0.0
0.2
0.2
2011
-3.4
0.4
0.9
0.6
0.8
0.6
0.6
1.0
-0.1
2012
5.0
3.7
3.2
2.9
2.6
2.1
1.7
1.6
1.2
2013
4.2
4.5
3.7
3.5
3.1
3.2
2.9
2.4
1.9
2014
0.7
1.1
1.3
1.5
1.7
1.3
1.3
1.2
1.3
2015
5.8
4.0
3.1
2.6
2.3
2.3
2.0
1.7
1.6
2016 (f)
5.2
4.8
1.9
1.4
1.6
2.2
2.3
2.2
2.1
2017 (f)
5.3
5.3
3.9
2.9
2.9
3.3
3.4
3.5
3.5
2018 (f)
5.0
5.0
3.9
2.9
2.8
3.1
3.3
3.3
3.4
2019 (f)
4.8
5.0
4.0
3.0
2.9
3.2
3.3
3.4
3.5
10
20
30
40
Median
60
70
80
90
1997-2007
2.3
2.1
2.1
2.1
2.1
2.1
2.2
2.3
2.5
2008
0.5
-0.3
0.1
0.6
1.2
1.8
2.1
2.5
-0.2
2009
1.3
1.2
0.8
0.8
0.6
0.5
0.6
0.3
1.4
2010
-5.0
-4.2
-3.6
-3.3
-3.5
-3.4
-3.2
-3.1
-3.1
2011
-7.6
-3.9
-3.5
-3.8
-3.6
-3.8
-3.7
-3.4
-4.4
2012
1.8
0.6
0.2
0.0
-0.3
-0.7
-1.1
-1.2
-1.5
2013
1.3
1.6
0.9
0.8
0.5
0.7
0.4
-0.1
-0.5
2014
-0.9
-0.6
-0.2
0.0
0.2
-0.1
-0.1
-0.2
-0.1
2015
5.7
3.8
3.1
2.7
2.4
2.3
2.0
1.7
1.6
2016 (f)
4.8
4.3
1.5
0.9
1.1
1.6
1.6
1.4
1.2
2017 (f)
3.4
3.4
2.1
1.2
1.1
1.5
1.8
1.9
2.0
2018 (f)
2.9
2.9
1.9
0.9
0.8
1.2
1.5
1.5
1.7
2019 (f)
2.5
2.7
1.7
0.8
0.8
1.1
1.3
1.4
1.6
Source: EY ITEM Club
Real take-home pay
Annual % change
Income percentiles
Source: EY ITEM Club
That said, over time, high earners are expected to see a relatively rapid pick-up in pay growth. In a world
of low unemployment, those possessing a high level of skills and experience will be in a position to
leverage their advantages more effectively. And further advances in technology will continue delivering
healthy rewards to those who possess complimentary skills.
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EY ITEM Club special report on consumer spending
The relative losers look like being middle-income earners, earning too much to gain from the NLW, but
whose skill levels leave them vulnerable to polarisation in the labour market, as routine white-collar and
skilled manufacturing jobs fall prey to growing automation. Our expectation is that those earning around
the median income level will see the weakest pay growth over the next few years. So the ‘squeezed
middle’ won’t see the pressure relieved anytime soon.
..but a chunk of the gain from the NLW will accrue to higher income
households
It is worth noting that the picture may be somewhat different if we consider income by household rather
than by individual. While the income boost from the NLW accrues overwhelmingly to low paid individuals,
it is projected to have a fairly even effect on the distribution of household incomes. This reflects the fact
that many workers on the NLW will be households’ second earners, while the bottom of the income
distribution tends to be dominated by pensioners and the unemployed. Indeed, the OBR predicts that
around half the cash gains in household income from the NLW may accrue to the top half of the
household income distribution. This will temper any boost to consumer spending from the new wage
floor, since the propensity to spend additional earnings tends to fall as household incomes rise.
In addition, to the extent that the adverse economic effects of the NLW discussed earlier materialise
over time, the gain to consumption will be even more muted. And the Chancellor’s decision to effectively
delay rather than cancel planned cuts to tax credits, along with continuing with other reductions in
welfare spending, means that the long-run effect of Mr Osborne’s plans still involves a sizeable hit to low
income households, far outweighing the boost from the NLW.
Older people will benefit from a narrowing income gap with the young
Demographic developments in the form of an ageing population offer another reason to think that
prospects for consumers are by no means uniform. In 1960, 6.3m people in the UK were aged 65 or
over. By 2012, this number had risen to 10.9m, before climbing to an estimated 11.7m in 2015. This
population is projected to reach 12.8m by the end of the decade. As far as incomes and consumer
spending power are concerned, an older population might be thought to be potentially bad news. But the
numbers go some way to belying this. In 2014, average gross income per person in the UK was £325
per week for households headed by someone aged 64 or younger. But the average gross income per
person within households headed by someone aged 65-74 was actually higher than this, at £332 per
week, falling to £289 for households aged 75 and older. The presence of (non-earning) children in many
working-age households would appear to partly offset the loss of work income for older households.
Moreover, elderly households are not necessarily less spendthrift than their younger peers. In 2014, the
average working-age UK household spent £221.80 per person per week. But this rose to £260 for
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EY ITEM Club special report on consumer spending
households headed by someone aged 65-74, before falling off to £201 for those headed by an individual
aged 75 or older.
Income and spending differentials between older households and the rest have narrowed in recent years
in favour of the former, not least because of the upward trend in employment rates among older people.
The number of people aged 65 or older in work reached a record 1.2m in late-2015, almost double the
676,000 recorded at the beginning of 2008. This increase represented a full 30% of the rise in total
employment over the same period. What’s more, the employment rate among the 65+ population
climbed from 7.2% to 10.7%, also a record high. And we expect this trend to continue, with continued
low annuity rates discouraging early retirement and legislated increases in the State Pension Age (SPA)
also pushing up the number of older people in work, boosting the average income of older households in
the process. The female state pension age is on course to rise to 65 by 2018 and the SPA for both men
and women will increase to 66 by 2020 and 67 by 2028.
Assuming current policies are maintained, elderly people will also continue to gain from the relative
generosity of the welfare system towards pensioners. Notably, the Government’s “triple-lock”
commitment means that the state pension rises by the higher of CPI inflation, average wages or 2.5%. In
contrast, working age benefits will be frozen in cash terms for four years from 2016-17.
Some narrowing in differentials from the average may also be observed in the incomes of young adults,
thanks to the aforementioned NLW. Since the NLW will not apply to workers aged below 25, firms may
choose to substitute younger for older workers, boosting the earnings and spending power of the former
at the expense of the latter. Evidence from countries which operate age-specific minimum wages
suggests that employers shed workers as they become older and more expensive, replacing them with
cheaper younger ones.6
6
For example, see Jan Kabátek (2016) “Happy Birthday, you're Fired!: The Effects of an Age-Dependent Minimum Wage on Youth
Employment Flows in the Netherlands”, (CentER Discussion Paper; Vol. 2016-001). Tilburg: CentER, Center for
Economic Research. https://pure.uvt.nl/portal/files/9478597/2016_001.pdf
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EY ITEM Club special report on consumer spending
Non-income drivers of consumer
spending
Appetite to save likely to see a modest revival…
Having explored prospects for income growth, we now turn to non-income drivers of spending. Since
income saved is income not spent, households’ saving behaviour is a crucial determinant of consumer
spending. The household saving ratio, which measures the difference between household resources and
expenditure, fell to an estimated 4.7% in 2015, the lowest since records began in 1963. This compares
with a recent peak of 11.6% in 2010, 8.8% in 2012 and 5.4% in 2014. And a ‘discretionary’ saving ratio,
which excludes income which goes directly to pension schemes and so is probably a more relevant
measures for most households, looks to have run at close to zero in 2015, broadly level with that seen
just before the financial crisis struck in 2008. Given the extent to which the headline saving ratio has
fallen and the possibility that memories of the financial crisis may have instilled a more prudent mindset
among households, we expect the saving ratio to see some increase in 2016, implying that consumer
spending will have to rely more on disposable income growth.
…but elevated wealth will support spending…
But the predicted rise is forecast to be modest, taking the saving ratio to 5½% this year. One reason to
exclude a sizable resurgence in savings is households’ buoyant aggregate wealth position. Net household
wealth (including housing and financial assets) reached 737% of household incomes in the third quarter
of 2015, above the pre-crisis peak (719% at the end of 2007) and close to a record high. Admittedly,
rising longevity and pressure to save more for retirement in the face of very low annuity rates mean that
growing levels of wealth are unlikely to translate into a consumer spending spree. And recent falls in
equity prices will have hit households’ financial wealth.
But it is too early to conclude that the market turbulence seen this year will be long-lasting. And since
direct holdings of equities account for only a modest share of households’ financial wealth, a negative
wealth effect from lower equity prices is likely to be modest. In Q3 2015, equites accounted for 10.3% of
total household financial assets, less than half the 21% held in the form of cash and bank deposits and
only a fifth of the 50% held via pension funds (a proportion of which will be in equities but where shortterm movements in prices are unlikely to affect spending decisions). Meanwhile, we forecast house
prices to rise by around 6½% this year, a similar pace to that seen in 2015, boosting a component of
household wealth that accounts for more than 50% of the (financial and non-financial) total. So wealth
levels are likely to remain elevated, which should mean that there is less pressure on households to save
more (and so spend less).
UK: Savings ratio
% of disposable income, 4QMA
14
Headline savings ratio
Discretionary saving
12
Forecast
10
8
6
4
2
0
-2
-4
2004
2006
2008
2010
2012
2014
2016
2018
2020
Source : EY ITEM Club
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EY ITEM Club special report on consumer spending
…as will cheap credit and robust household balance sheets…
Meanwhile, consumers’ appetite to borrow is likely to remain healthy. Borrowing costs on unsecured
loans are close to record lows, with average interest rates on personal loans of £5,000 and £10,000
falling by 380 basis points (bps) and 245bps respectively since the beginning of 2013. Recent drops in
market interest rate expectations should translate into even lower borrowing costs. Credit is also
becoming increasingly available — unsecured lending (which includes personal loans, overdrafts and
credit cards) rose by over 8% year-on-year in the last quarter of 2015, in line with pre-financial crisis
rates. This has led to speculation that the Bank of England’s Financial Policy Committee (FPC) may take
action to cool lending in this area. But with consumer debt as a share of incomes still around 30
percentage points below the pre-crisis peak and growth in the much more important mortgage element
of borrowing remaining relatively subdued, the FPC may choose to hold back and see whether the recent
frothiness of credit growth eases of its own accord.
UK: Household debt & interest ratios
%
180
170
%
12
Debt-to-income ratio (LHS)
11
Interest-to-income ratio (RHS)
10
160
9
150
8
140
7
130
6
5
120
4
110
3
100
2
1997 1999 2001 2003 2005 2007 2009 2011 2013 2015
Source : EY ITEM Club/Haver Analytics
Moreover, the relative strength of household balance sheets suggests that there is room for consumers
to take on more debt before warning bells start ringing. This strength partly relates to the high level of
household wealth referred to earlier. And the picture on the liabilities side also looks more robust than it
has done for some time. As a share of incomes, total household debt dipped to 142.5% in Q3 2015, the
lowest since late 2003, compared with a peak of 168.2% reached at the beginning of 2008.
At the same time, debt servicing costs at the end of the 2015 were at their lowest relative to incomes
since records began in 1987. The ratio of total interest payments to income was 4.9% in the third
quarter of 2015, less than half the 2008 peak. This partly reflects the Bank of England maintaining
interest rates at a record low of 0.5%, a situation we do not expect to change until the end of 2016 at
the earliest. A historically low household debt interest burden is also a consequence of a shift away from
home ownership (and associated mortgage debt) — 2014 saw the share of households holding a
mortgage at the lowest for more than 30 years. And households in that category look to be in a better
position to face an interest rate rise when that finally happens. 2015’s Bank of England/NMG survey of
household finances showed 31% of mortgage holders would cut back spending or work longer hours if
interest rates rose by two percentage points, down from 37% in 2014, and 44% in 2013. 7
…and high levels of consumer confidence
The final non-income ingredient that points to 2016 being another healthy year for consumer spending
is an elevated level of consumer confidence. Although the GfK survey’s headline measure of sentiment
slipped at the end of 2015 from the 15-year high seen in the middle of last year, it remained very strong
7
“The potential impact of higher interest rates and further fiscal consolidation on households: evidence from the 2015 NMG
Consulting survey”, Bank of England Quarterly Bulletin, 2015 Q4.
http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2015/q404.pdf
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EY ITEM Club special report on consumer spending
by historical standards (a balance of +2 in the three months to January 2016 compared to an average of
-9 from 1996-2014). A similar story is true regarding the survey’s measure of shoppers’ appetite to
make major purchases. Granted, there are risks to confidence from an intensification of economic
troubles overseas and uncertainty around the forthcoming referendum on EU membership. But low
levels of unemployment and continued growth in house prices should keep consumer sentiment
elevated.
UK: Proportion of mortgagors that would
need to respond to a rise in mortgage rates
% mortgagors
60
2013 NMG survey responses
2014 NMG survey responses
2015 NMG survey responses
50
40
30
20
10
0
0.0
1.0
2.0
Rise in Bank Rate ( % points)
3.0
Source : NMG Consulting survey and Bank calculations
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EY ITEM Club special report on consumer spending
Forecasts for consumer spending
Consumer spending growth this year should match 2015’s pace
but slow sharply thereafter
Overall, we expect that the tailwinds which supported the consumer last year will continue to manifest
themselves in 2016, pointing to consumer spending growth matching 2015’s 2.9% increase. Although
rising inflation will, all else equal, exert a modest drag on real income growth, this should be offset by a
pick-up in growth in cash earnings. And post-tax pay will gain from a more generous tax allowance. That
said, while low earners in work will see a sizable gain from the NLW, the boost to overall household
incomes will be tempered given the indirect adverse consequences for employment and GDP. And that
the benefits of the NLW’s more generous wage floor will to a sizeable degree accrue to higher income
households is set to dampen the effect of the NLW on consumer spending.
Meanwhile, 2015’s story of real consumer strength but nominal weakness is set to remain broadly true
this year. Although 2016 should see rising inflation push up cash growth in spending to 3.5% from 3.1%
a year earlier, this will still be well below the 5.5% averaged in the decade prior to the financial crisis.
The picture becomes less positive further out.
Beyond 2016, momentum in real income growth is
likely to ease, reflecting a continued rise in
inflation, a slowdown in employment growth and
the effect of government policies, notably the
escalating impact of the welfare cuts and the
introduction of the apprenticeship levy. We expect
annual growth in real household incomes to
average a modest 1½% to 2% from 2017 to 2020.
With the household saving ratio forecast to
stabilise around 5%, slower income growth will
translate into softer growth in consumer spending,
also predicted to run at 1½% to 2% annually, a
marked easing on the pre-crisis norm (3.9% from
1997 to 2007). Rising inflation implies a narrower
gap between cash and real growth, with nominal
spending rising by 3.8% annually in the three years
to 2020.
UK: Real household income and spending
% year
5
Household
income
Forecast
4
3
2
1
0
-1
-2
-3
-4
-5
-6
2004
Household
spending
2006
2008
2010
2012
2014
2016
2018
2020
Source : EY ITEM Club
Discretionary strength set to continue
As far as prospects for different sectors are concerned, the recovery in discretionary spending observed
last year, supported by strong growth in real incomes, should continue in 2016 and beyond. For
example, spending on transport in 2016 is predicted to exceed the already strong rate of growth seen in
2015. New car registrations reached a record high of 2.63m in 2015, reflecting cheap financing and the
continued release of pent-up demand that had accumulated post-2008. Indeed, spending on cars rose
by almost 10% in volume terms. With real incomes set for another healthy rise in 2016 and financing
likely to get even cheaper, car sales are forecast to dip only slightly from 2015’s record high. However,
as pent-up demand is exhausted and interest rates start to rise, the pace of growth in car sales is likely
to tail off from 2017 onwards. But transport’s share of real spending will also be boosted by petrol prices
remaining longer for longer.
Similarly, leisure (encompassing recreation and culture and restaurants and hotels) should continue to
enjoy at or above-average growth in spending as incomes continue to rise and people have more money
for spending on non-essentials. Meanwhile, a humming housing market characterised by robust price
growth and rising transactions will support household goods purchases like furniture.
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EY ITEM Club special report on consumer spending
Health-related products such as medicines,
prescriptions and glasses should benefit from an
ageing population, with the same development
supporting that element of housing spending
devoted to home maintenance (DIY and the
services of plumbers, electricians etc.). Health and
home maintenance are the only categories where
elderly households spend more per person than UK
households as a whole.
Granted, patterns in spending by age suggest that
clothing and footwear sales are likely to lose out
from an older population, particularly sales of
men’s fashion. But as an important element of
discretionary spending, this category should still
post strong volume gains in coming years.
Consumer spending forecasts
Constant 2012 prices, annual % change
1998-2007
2008-2014
2015 (f)
2016 (f)
2017 (f)
2018-2020
(f)
Recreation & Culture
8.4
1.8
7.0
7.8
6.9
4.5
Communications
8.6
0.4
5.2
7.9
4.6
3.0
Health
5.1
2.8
-0.9
6.5
3.0
2.8
Household Goods
4.6
-1.0
4.2
5.6
3.0
2.4
10.6
5.9
5.0
6.8
3.3
2.3
Housing
1.3
0.8
2.2
0.5
1.5
1.8
Hotels & restaurants
0.9
-0.4
1.4
2.8
0.8
1.3
Food & Non-alcoholic drinks
1.7
-0.5
0.8
2.6
0.7
1.2
Miscellaneous
3.0
0.1
0.7
1.2
-0.4
1.2
Transport
2.7
0.0
4.4
5.7
0.9
0.8
Education
-0.4
-2.4
0.5
2.5
-0.1
-0.4
Alcohol & Tobacco
-0.5
-2.4
-2.1
-1.0
-2.5
-1.1
Total
3.8
0.3
2.9
2.9
2.1
1.9
Clothing & footwear
Source: EY ITEM Club
In nominal, or cash, terms, a continued imbalance between the supply of, and demand for, homes is
likely to push up rents, increasing growth in cash spending on housing. But cuts in energy bills will have
an opposing effect, with all of the ‘big six’ energy firms having already announced cuts in gas bills to
take effect early this year.
In other respects, the shape of the nominal forecast differs from that for volumes. Spending on
recreation and culture is predicted to see slower growth in cash terms, reflecting the tendency for the
price of new technology to decline as production ramps up. And the share of spending devoted to food is
likely to continue falling. This reflects the lagged effects of the prolonged decline in agricultural
commodity prices, continued pressure on traditional supermarkets from discount retailers and the
tendency for the share of spending on necessities to decline as incomes rise.
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EY ITEM Club special report on consumer spending
Consumer spending forecasts
Current prices, annual % change
1998-2007
2008-2014
2015 (f)
2016 (f)
2017 (f)
Housing
6.6
Communications
2018-2020 (f)
5.8
3.3
2.5
5.0
5.4
6.4
2.7
6.5
9.9
6.7
5.2
Clothing & footwear
4.7
4.1
5.7
6.6
4.3
3.9
Education
6.2
6.8
8.3
6.7
4.7
3.7
Recreation & Culture
5.4
1.3
6.0
4.4
3.8
3.6
Household Goods
4.4
1.3
4.6
6.7
4.2
3.6
Miscellaneous
5.9
1.2
1.5
3.3
2.0
3.3
Transport
5.1
3.1
3.9
5.4
3.7
3.3
Hotels & restaurants
4.5
3.0
3.8
4.6
2.8
3.2
Food & Non-alcoholic drinks
3.2
3.7
-1.6
2.4
1.8
2.0
Alcohol & Tobacco
3.4
3.3
0.2
1.6
0.5
1.7
Health
2.3
1.5
0.6
2.5
1.7
1.5
Total
5.3
3.2
3.1
3.5
3.8
3.9
Source: EY ITEM Club
EY  19
EY ITEM Club special report on consumer spending
Conclusion
After a fairly subdued performance over much of the current economic expansion, 2015 was a bountiful
year for consumer spending, driven by an unusually benign backdrop of ‘noflation’. But last year’s
consumer revival was an unusual one, much more apparent in real than nominal terms. 2016 is set to
see more of the same, with the various tailwinds supporting the consumer suggesting that growth in real
spending should match 2015’s post-crisis high of 2.9%.
But very low inflation will continue to play a major role in supporting that growth. In that respect,
consumers have been and, for this year at least, will continue to be lucky, with the lack of any serious
drag from inflation disguising some less welcome developments. While a tighter labour market should
bring forth more generous pay rises, pay growth will continue to be held back by structural changes in
the UK labour market. And although low-earning individuals will gain from the NLW, the boost to overall
consumption may prove to be fairly subdued, particularly in light of the extent to which higher income
households will receive much of the gains. And the welfare cuts that had been due to hit in April this
year will eventually make their presence felt.
Granted, forces supporting consumer spending will be far from out of ammunition. Borrowing costs are
set to stay exceptionally low, joblessness should stay down and household balance sheets are in good
shape. But beyond this year, as inflation picks up further and fiscal austerity bites, growth in both real
household incomes and spending is set to slow to rates more in line with the post-crisis norm. In
conclusion, “make hay while the sun shines” would seem an appropriate message for consumers to take
to heart.
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EY ITEM Club special report on consumer spending
Appendix — consumer spending
categories
COICOP
Items included
Food & non-alcoholic
drinks
Bread and cereals; meat; fish; milk, cheese & eggs; oils & fats;
fruit; vegetables' sugar & sweet products; food products n.e.c;
coffee, tea & cocoa; mineral water & soft drinks
Spirits; wine; beers; tobacco
Clothing materials; garments; other articles of
clothing/accessories; cleaning, repair & hire of clothing; shoes &
other footwear; repair & hire of footwear
Actual rents paid by tenants for housing; other actual rents;
imputed rents of owner occupiers; other imputed rentals;
materials for maintenance and repair of the dwelling; services for
maintenance and repair of the dwelling; water supply; refuse
collection; sewerage collection; other dwelling related services;
electricity; gas; liquid fuels; solid fuels; heat energy
Furniture & furnishings; carpets & other floor coverings; repair of
furniture & floor coverings; household textiles; major household
appliances; small electric household appliances; repair of
household appliances; household utensils; major tools &
equipment; small tools & minor accessories; non-durable
household goods; domestic & household services
Pharmaceutical products; other medical products; therapeutic
equipment; outpatient medical services; dental services;
paramedical services; hospital services
Motor cars; motor cycles; bicycles; motor vehicle spares; vehicle
fuels & lubricants; vehicle maintenance & repair; other vehicle
services; railways; road; air; sea & inland waterways; other
transport services
Postal services; telephone & fax equipment; telephone & telefax
services
Audio visual equipment; photographic & optical equipment;
information processing equipment; recording media; repairs of
audio visual equipment; major durables for outdoors recreation;
musical instruments & major durables for indoor recreation;
maintenance of other major durables; games, toys & hobbies;
sports, camping & open-air recreation equipment; gardens, plants
& flowers; pets & related products; veterinary & other services;
recreational & sporting services; cultural services; games of
chance; books; newspapers & periodicals; miscellaneous printed
matter; stationary & drawing materials; package holidays
Education
Restaurants, cafes, etc; canteens; accommodation services
Hairdressing & personal grooming; electric appliances for personal
care; other products for personal care; jewellery, clocks & watches;
other personal effects; social protection; life insurance; dwelling
insurance; health insurance; transport insurance; other insurance;
other financial services; other services
Alcohol & tobacco
Clothing & footwear
Housing
Household goods
Health
Transport
Communications
Recreation & culture
Education
Hotels & restaurants
Miscellaneous
EY  21
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