Brexit vote will lead to cut in disposable incomes in 2017, says thinktank

British households can expect a cut in their disposable incomes next year as the knock-on effects of the vote to leave the European Union send inflation rocketing and weaken the outlook for the economy.

The government’s freeze on tax credit payments will also play a part in dragging down real disposable incomes for the first time in four years, according to forecasts by the National Institute of Economic and Social Research (NIESR).

Revealing a worsening outlook after the collapse in the pound and slump in business investment, the NIESR’s forecasts showed the UK suffering a huge aftershock from the Brexit vote that “could still lead to a recession”.

The thinktank warned that the 0.5% reversal in real household disposable incomes in 2017 would hurt the wider economy, pushing down GDP growth to 1.4% from the 2% the UK is expected to enjoy this year.

The NIESR’s quarterly health check came as the CBI business lobby group cut its forecast for GDP growth next year from 2% to 1.3%.

The CBI said average wages would continue to increase next year, rising by 2.8% compared to this year’s 2.6%, but soaring inflation would more than wipe out the gains, hitting consumer incomes.

Three weeks before the chancellor, Philip Hammond, delivers his first autumn statement, Rain Newton-Smith, the CBI’s chief economist, said businesses were on the lookout for tax incentives to boost investment.

She said: “Certainty and stability, vital ingredients that allow businesses to invest and create jobs across the UK, have been absent since the vote to leave the European Union.

“Now, with the economic outlook tempered, business leaders will be looking to the chancellor to incentivise investment and instil confidence when he delivers his autumn statement.”

The TUC general secretary, Frances O’Grady, said workers should be shielded from bearing the brunt of rising prices, after the prime minister, Theresa May, pledged in her speech to the Conservative conference to protect families who were “just managing”. “A fall in growth would leave workers paying the price through fewer jobs and lower wages,” O’Grady said.

The NIESR said that per capita disposable income, which measures the combined incomes from wages and benefits of all households, will fall by 0.5% next year, mainly in response to a forecast jump in consumer price index (CPI) inflation to 3.9%, almost double the rate targeted by the Bank of England.

The higher-than-expected inflation rate will dwarf rising average incomes, which will be dragged down by a cap on public sector wages, a freeze on in-work benefits and lacklustre private sector wage rises next year. A spike in inflation is expected following the slump in sterling, which is beginning to push up the cost of imported goods.

A report by Merrill Lynch forecast a further slump in the pound in early 2017 to $1.15, from $1.22, which it predicted would further raise import prices and push inflation even higher.

Analysts at the investment bank said investors had failed to judge the impact of the government’s intention to trigger article 50 by March 2017, which will mark the beginning of negotiations with Brussels and generate “a frequent and potentially contradictory Brexit news flow”.

The NIESR said it forecast a rise in inflation to almost 4% next year after is assumed the pound would stabilise against the dollar following an 18% fall since the referendum. A further tumble in the exchange rate could push inflation even higher.

Simon Kirby, an NIESR economist, said: “The depreciation of sterling has been the most striking feature of the post-referendum economic landscape. This will pass through into consumer prices over the coming months and quarters.

“By the end of 2017 we expect CPI to have reached almost 4%. While we expect this to be only a temporary phenomenon, it will nonetheless weigh on the purchasing power of consumers over the next couple of years.”

Consumer spending has propped up GDP growth in the last year after a sharp downturn in construction and weaker manufacturing sector, which has lost momentum in response to slowing growth in global trade.

The most recent assessment of the UK economy by the Office for National Statistics showed that manufacturing contracted in the three months to the end of September by 1%. A survey of manufacturers in October found that the sharp fall in the value of the pound since the EU referendum had helped to increase exports, but also forced manufacturers to raise the price of their goods at the fastest rate in more than five years.

The latest Markit/CIPS manufacturing purchasing managers’ index (PMI) survey for October suggested that firms are starting to pass on higher import costs as the weak pound makes raw materials such as oil more expensive. Prices of everyday items including clothing, wine, bread and fruit are expected to come under increasing pressure as Brexit nears. However, the weak exchange rate also helped to boost orders from the US, the EU and China.

Rob Dobson, a senior economist at IHS Markit and an author of the report, said the manufacturing sector should return to growth in the fourth quarter.