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Why consumer confidence has wobbled following the EU vote

Economy Watch by Danske Bank economist Conor Lambe

Consumer spending is the main driver of the UK economy. Spending by households makes up over 60% of the UK's GDP. In 2015, the UK economy grew by 2.2% and consumer spending was responsible for 1.5 percentage points of that growth.

So the behaviour of consumers will clearly have significant implications for economic growth in the UK, and in Northern Ireland, in 2017.

Given the importance of consumer spending to the local economy, the Danske Bank Northern Ireland Consumer Confidence Index is published every quarter to gauge how optimistic consumers are feeling and how likely they are to spend in the months ahead.

The index consists of four sub-components. These are consumers' opinions of how their current financial position compares to the previous year, expectations of how their financial position will change over the next 12 months, ratings of job security over the next year and expectations of the amount they will spend on high value items, such as furniture and holidays, over the coming 12 months.

We also collect data on consumers' expectations of the amount they will save in the next year, although this doesn't feed into the overall index number.

We have data going back to the third quarter of 2008 and our index is constructed so that the value in that quarter is set to 100.

The overall index hit its lowest point, with a value of 94, in the third quarter of 2011, and peaked at 141 in the third quarter of 2015.

In the third quarter of 2016, following the EU referendum, our consumer confidence index fell by two points to a value of 137.

Last week, we published the index for the fourth quarter of 2016 which revealed that consumer confidence dropped by another five points, down to 132 in the final quarter of the year.

This also represented a fall of three points when compared with the last quarter of 2015.

The drop in the overall value of the index suggests that the uncertainty that has come about following the outcome of the Brexit vote is weighing on consumer sentiment.

This is not entirely unexpected, given that Northern Ireland was one of the UK regions that voted to remain in the EU and it would be the hardest-hit region if there is a significant change to the border arrangements with the Republic of Ireland.

Looking at the sub-components of the index also reveals some interesting information. The sub-index based on opinions of how consumers' financial position compares to the previous year fell over the quarter and over the year.

The fact that consumers feel less confident about their finances relative to last year could be partly explained by the fact that inflation is rising. In December 2015, UK inflation stood at 0.2%.

But the inflation rate was 1.6% at the end of last year. Therefore, some household budgets may have felt relatively more squeezed at the end of 2016 compared with the end of 2015.

The largest fall across the sub-components of the index was in the series on expectations of how households' financial position will change over the next 12 months.

The sharp decline in this part of the index is consistent with expectations of higher prices in the year ahead.

Inflation is likely to move above the Bank of England's 2% target later in 2017 and this will squeeze real wage growth and put downward pressure on consumers' purchasing power.

This can also help explain why consumers' expectations of the amount they will spend on high value items over the next year dropped by seven points over the quarter and one point over the year.

However, the latest survey unveiled some encouraging news about the labour market. Consumers' expectations about job security rose in the final quarter of last year. The unemployment rate in Northern Ireland currently stands at 5.6% which is above the rate in the rest of the UK but lower than it was for 2014 and 2015.

The number of people claiming unemployment-related benefits in Northern Ireland also fell for the ninth month in a row in December 2016.

It is possible that the unemployment rate could rise this year in light of the Brexit-related uncertainty, but consumers seem to be buoyed by the recent performance of the local labour market and are optimistic it won't experience a sharp downturn in the short-term.

Turning to savings, our survey revealed that 9% of respondents expect to save more than in the last year, but 20% expect to save less. This could be because consumers expect to have less disposable income left over for saving this year.

Our index shows that consumer confidence fell in both quarters following the EU referendum, and that consumers feel less optimistic about making large purchases this year.

However, the low interest rate environment continues to support households, and consumers will keep spending on smaller items and leisure activities over the next 12 months.

Therefore, it is likely that consumer spending will rise this year but we think that the rate of growth will slow and this is supported by the drop in confidence levels shown by our latest survey.

In next week's Economy Watch, we hear from Andrew Webb of Webb Advisory

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