By Conor Lambe, Economist at Danske Bank
Services are the driving force of the UK economy. While often talked about as a single sector, there are a number of individual services industries, ranging from financial services to retail trade to transport services. Taken together they account for almost 80 per cent of UK GDP, therefore their performance will be an important driver behind the fortunes of the UK economy during the next two years of Brexit negotiations.
Broadly speaking, the combined services sector has come through the post-referendum period in reasonably good shape. Looking at the monthly growth rate, based on the most recent three months compared with the previous three months, every data point since the referendum shows rising services output.
However, there are some signs that growth is beginning to slow. The three-month on three-month growth rate in January continued a trend of softening growth which has been underway since November 2016. A glance at the month-on-month growth rates, which it should be noted are generally more volatile, shows that services activity actually fell between December and January. And while the latest UK Services Purchasing Managers’ Index (PMI) picked up in March, the data still implies that economic growth will be slower in the first quarter of 2017 than in the final quarter of last year.
However, the outlook for the services sector over the next couple of years varies according to industry, with some expected to perform relatively well and some likely to be hit harder.
Professional services businesses, such as law firms and management consultancies, are likely to find themselves in demand as the UK prepares to leave the EU. It might be expected that businesses like these would perform better when the economy is growing quickly because firms feel more bullish about expanding, entering into new markets, or engaging in M&A activities when the economy is experiencing a boom. However, given the changes to the business environment that leaving the European Union will likely result in, many businesses will engage professional services firms to help them assess the potential impacts of Brexit on their organisation. This could involve examining their supply chains, reliance on EU workers or future investment plans, or perhaps reviewing their legal structure and any changes they may consider making after Brexit occurs. The latest data shows that the output of professional services firms is rising and the outlook, for the next couple of years at least, is relatively bright.
For businesses in the consumer-focused services industries, such as retailers, hotels, restaurants and leisure providers, there are headwinds on the horizon. Higher inflation will put pressure on household budgets and squeeze consumer spending. With inflation likely to rise further in the months ahead, growth is expected to slow as we move through this year and into 2018.
Official data shows that the financial services sector has kept growing following the EU referendum. This is expected to continue over the next couple of years but there is a downside risk that, in the event of a spike in uncertainty levels during the Brexit negotiations if the talks hit a stumbling block, business investment could be hit harder than currently expected and banks could see a softening in demand for credit. Despite this, the biggest risk for the financial services sector remains a longer-term one – that they will face restrictions on access to EU markets due to a loss of passporting rights once the UK leaves the single market.
In Northern Ireland, services make up around 74 per cent of Gross Value Added (GVA). Focusing on the local economy, we expect three services sectors to be the fastest growing over the next two years. Information and communication is expected to be the best performing sector, with the professional, scientific and technical, as well as the administrative and support sectors, also growing strongly.
Much like for the UK as a whole, the consumer-orientated sectors in Northern Ireland are expected to perform relatively well on average across 2017. However, growth is likely to be lower in 2018 as higher inflation weighs down on consumer spending. The wholesale and retail trade sector, which makes up around fifteen per cent of GVA, is the largest sector of the Northern Ireland economy. We expect it to grow by 2.6 per cent this year, but by only 1.8 per cent in 2018.
Looking further ahead, businesses in the services sector will be watching the Brexit negotiations closely, with a focus on the terms of the UK’s hoped-for free-trade agreement with the EU. Much emphasis has been on to what extent this deal will reduce tariffs on goods, but it is non-tariff barriers, such as differences in regulations, that can make it difficult for services businesses to sell overseas. It remains to be seen just how far the prospective free-trade deal between the UK and EU will go towards minimising these barriers. For many service providers, this is one area that they’ll need to monitor very carefully over the next few years.
This article was published in The Irish News on 11th April 2017.