3/26/2010

Prospects for the UK economy  into 2010 Geoff Riley Head of Economics, Eton College March‐April 2010

Forecasts for the UK economy Variable

2009

2010

‐4.7

1.2

Real GDP

% change

CPI Inflation CPI Inflation

Q4 in each 1.7 Q4 in each  17 year

18 1.8

Claimant  unemployment

Q4, million 1.71

1.92

Fiscal deficit

£ billion

181bn

177bn

Source: HM Treasury survey of  independent economic forecasts

1

3/26/2010

Components of aggregate demand Variable

2009

2010

Real GDP

% change

‐4.7

1.2

Household consumption

% change % change

‐3 1 ‐3.1

02 0.2

Government consumption

% change

2.3

1.3

Capital investment

% change

‐15.0

‐3.0

Exports

% change

‐10.7

3.3

Imports

% change

‐12.3

2.1

Source: HM Treasury survey of  independent economic forecasts

Percent

Will there be a strong rebound in 2010?

2

3/26/2010

Real GDP over the long term UK Real National Output 350

325

325

300

300

275

275

250

250

225

225

200

200

175

175

150

billions

GBP (billions)

Quarterly value of real GDP 350

150 79

80

81

82

83

84

85

86

87

88

89

90

91

92

93

94

95

96

97

98

99

00

01

02

03

04

05

06

07

08

09

Source: Reuters EcoWin

thousand billions

GBP (thousand billions)

GDP is well below potential

3

3/26/2010

Leading to a lot of spare capacity UK Economy - Output Gap Difference between actual and potential GDP, % of potential GDP 5

5

4

4

3

3

2

2

1

1

0

0

-1

-1

-2

-2

-3

-3

-4

-4

-5

-5

-6

-6

-7

-7 80

81

82

83

84

85

86

87

88

89

90

91

92

93

94

95

96

97

98

99

00

01

02

03

04

05

06

07

08

09

10

11

Source: OECD World Economic Outlook

millions

Percent

Person (millions)

Cyclical unemployment was unavoidable

4

3/26/2010

per cent of the labour force

But rise in U is smaller than previous recessions

Flexibility (1): Hours have been cut UK - Total actual weekly hours worked Million hours per week 950

950

940

940

930

930

920

920

910

910

900

900

890

890

880

880

870

870

860

860

850

850

840

840

830

830

820

820 92

93

94

95

96

97

98

99

00

01

02

03

04

05

06

07

08

09

10

Source: Reuters EcoWin

5

3/26/2010

Flexibility (2): Wage growth has slowed Unemployment and Wage Inflation in the UK Economy Annual percentage change in average earnings and % unemployment rate

6

6

5

5 Wage Inflation

4

4

3

3

Unemployment (Claimant Count)

2

2

1

1

0

0

-1

-1

97

98

99

00

01

02

03

04

05

06

07

08

09

10

Source: Reuters EcoWin

But long term unemployment is rising UK Unemployment, By Duration Millions, seasonally adjusted, using Labour Force Survey data

1.50

1.50

1.25

1.25

Unemployed for up to six months 1.00

1.00

0.75

0.75

Unemployed for over 12 months

0.50

0.50

0.25

0.25

Unemployed for over 24 months

0.00

0.00

92

93

94

95

96

97

98

99

00

01

02

03

04

05

06

07

08

09

10

Source: Reuters EcoWin

6

3/26/2010

Youth unemployment remains a key issue Long Term Unemployment for people Aged 18-24 Thousands, people out of work for at least a year

275000

275000

250000

250000

225000

225000

200000

200000

175000

175000

150000

150000

125000

125000

100000

100000

75000

75000

50000

50000

25000

25000

93

94

95

96

97

98

99

00

01

02

03

04

05

06

07

08

09

10

Source: Reuters EcoWin

millions

Person (millions)

The pattern of employment continues to change

7

3/26/2010

Reflecting differences in sector output UK Manufacturing and Service Industry Output Index of Production (Value Added), 2002=100, measured at Constant Prices, Seasonally Adjusted

110

110

100

100

Manufacturing

90

90

80

80

70

70

Services

60

60

50

50

88

89

90

91

92

93

94

95

96

97

98

99

00

01

02

03

04

05

06

07

08

09

Source: Reuters EcoWin

Macroeconomic policy An unprecedented policy easing has  attempted to stabilise demand and attempted to stabilise demand and  output and lower the risks of deflation

8

3/26/2010

Percent

Policy rate cuts to avoid a depression

And to reduce the risks of price deflation

9

3/26/2010

But ask small businesses about cost of credit The Cost of Borrowing Money in the UK Economy Per cent, source: Bank of England

20.0

20.0

Overdrafts

18.0

18.0

Percent

Credit cards

16.0

16.0

14.0

14.0

12.0

12.0

10.0

10.0

8.0

8.0

Mortgage rates

60 6.0

60 6.0

4.0

4.0 Base Interest Rates (set by BoE)

2.0

2.0

0.0

0.0 Jan

Apr

Jul 04

Oct

Jan

Apr

Jul 05

Oct

Jan

Apr

Jul 06

Oct

Jan

Apr

Jul 07

Oct

Jan

Apr

Jul 08

Oct

Jan

Apr

Jul 09

Oct

Jan 10

Source: Bank of England

Cheaper mortgages boost spending power Policy Interest Rates and other Borrowing Costs Monthly interest rates (end of month) 14.0

14.0

Unsecured £10000 loan 12.0

12.0

10.0

10.0

8.0

Variable Rate Mortgage

8.0

6.0

6.0

4.0

4.0 BoE Base Interest Rate

2.0

2.0

0.0

0.0 00

01

02

03

04

05

06

07

08

09

10 Source: Bank of England

10

3/26/2010

billions

GBP (billions)

Percent

But many have opted to pay back debt

And save more Household Savings Ratio and growth of Real Household Consumption Consumption (top pane) annual % change / Household Saving (bottom pane) % of disposable income 6

6

Annual % change

Real Consumer Spending 5

5

4

4

3

3

2

2

1

1

0

0

-1

-1

-2

-2

-3

Percent of disposable income

14.0

-3 14.0

Household Saving Ratio

12.0

12.0

10.0

10.0

8.0

8.0

6.0

6.0

4.0

4.0

2.0

2.0

0.0

0.0

-2.0

-2.0 90

91

92

93

94

95

96

97

98

99

00

01

02

03

04

05

06

07

08

09

10

Source: UK Statistics Commission

11

3/26/2010

House prices are rising again – but for how long? House Prices and Consumer Confidence index of confidence (top pane) and average prices per month (bottom pane)

Average price in £s

Index of conffidence

5

5

0

0

-5

-5

-10

-10

-15 15

-15 15

-20

-20

-25

-25

-30

-30

-35

-35

-40

-40

200000

200000

180000

180000

160000

160000

140000

140000

120000

120000

100000

100000 Average House Price for UK (Halifax house price data)

80000

80000

Jan

May Sep 03

Jan

May Sep 04

Jan

May Sep 05

Jan

May Sep 06

Jan

May Sep 07

Jan

May Sep 08

Jan

May Sep 09

Jan 10

Source: HBoS House Price Index and EcFin Consumer Confidence Data

And signs of a rebound in house building Construction Sector Confidence and Housing Starts Number of new houses started each month (top pane) and confidence (lower pane) 50000

50000

40000

40000

30000

30000

20000

20000

10000

10000

0

0

10

10

0

0

-10

-10

-20

-20

-30

-30

-40

-40

-50

-50

-60

-60 Q1

Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 05 06 07 Monthly housing starts in England Construction Sector Confidence indicator

Q1

Q2

Q3 08

Q4

Q1

Q2

Q3

Q4

09 Source: Reuters EcoWin

12

3/26/2010

Ratio of house prices to average earnings

If you can get a mortgage – affordability is good

(Quantitative) Easing the Pain

• Commercial Paper   • Corporate Bonds  • Government Gilts 

£548m £1,533m £181,275m

13

3/26/2010

LIBOR is now back to ‘normal’ Base Rates and the London Interbank Lending Rate Percentage, since May 1997 base rates have been set by the Bank of England

7.0

7.0

6.5

6.5 LIBOR 3-Month Interest Rate

6.0

6.0

5.5

5.5

5.0

5.0

Percent

4.5

4.5

Bank of England Base Rate

4.0

4.0

3.5

3.5

3.0

3.0

2.5

2.5

2.0

2.0

1.5

1.5

1.0

1.0

0.5

0.5

0.0 Jan

0.0

Apr

Jul 05

Oct

Jan

Apr

Jul 06

Oct

Jan

Apr

Jul 07

Oct

Jan

Apr

Jul 08

Oct

Jan

Apr

Jul 09

Oct

Jan

Apr

Jul 10

Oct

Source: Bank of England

Percent

But lending has stalled – banks hoarding cash?

14

3/26/2010

Government bond yields edge higher Bond Yields and Short Term Interest Rates Daily yields, per cent 7

7

LIBOR 3 month rate (%)

6

6

5

5

Yield on 10 year government bond 4

4

3

3

2

2

1

1 BoE Base Rate

0 Jan

0 Mar

May

Jul 06

Sep

Nov

Jan

Mar

May

Jul 07

Sep

Nov

Jan

Mar

May

Jul 08

Sep

Nov

Jan

Mar

May

Jul 09

Sep

Nov

Jan

Mar 10

Source: Bank of England

The lower £ has boosted competitiveness Sterling and Base Interest Rates Trade-weighted index value for sterling in the foreign exchange market, daily value 6.0

6.0

5.0

5.0 Base Interest Rates

4.0

4.0

3.0

3.0

2.0

2.0

1.0

1.0

0.0

0.0

110

110 Sterling Exchange Rate Index (trade-weighted)

105

105

100

100

95

95

90

90

85

85

80

80

75

75

70 Jan

70

Mar

May

Jul 07

Sep

Nov

Jan

Mar

May

Jul 08

Sep

Nov

Jan

Mar

May

Jul 09

Sep

Nov

Jan

Mar 10

Source: Reuters EcoWin

15

3/26/2010

Sterling has flirted with parity v the Euro Euro - Sterling Exchange Rate Value of one Euro, daily closing exchange rate

Pence per Euro1

0.96

0.96

£1 buys Euro 1 here

0.95

0.95

0.94

0.94

0.93

0.93

0.92

0.92

0.91

0.91

0.90

0.90

0.89

0.89

0.88

0.88

0.87

0.87

0.86

0.86

0.85

0.85

0.84

0.84

Jan

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

Dec

Jan

09

Feb 10

Mar Source: Reuters EcoWin

But some appreciation against a weak US $ Dollar-Sterling Exchange Rate US dollars per £1, daily closing exchange rate 2.2

2.1

2.1

2.0

2.0

1.9

1.9

1.8

1.8

1.7

1.7

1.6

1.6

1.5

1.5

1.4

1.4

GBP/USD

2.2

1.3 Jan

1.3 Mar

May

Jul 07

Sep

Nov

Jan

Mar

May

Jul 08

Sep

Nov

Jan

Mar

May

Jul 09

Sep

Nov

Jan

Mar 10

Source: Reuters EcoWin

16

3/26/2010

thousand billions

US Dollars (thousand billions)

UK exports were hit by trade slump in 2009

Drop in investment threatens sustainable upturn Value of UK Capital Investment Spending Quarterly value of capital spending at constant 2003 prices, £ billion 65

60

60

55

55

50

50

45

45

40

40

35

35

billions

GBP (billions)

65

30

30 90

91

92

93

94

95

96

97

98

99

00

01

02

03

04

05

06

07

08

09

Source: UK Statistics Commission

17

3/26/2010

And labour productivity has taken a hit UK Labour Productivity and the Economic Cycle Annual % change in output per worker for the whole economy

5

5

4

4

Real GDP 3

3

2

2

1

1

Labour productivity 0

-1

-1

-2

-2

-3

-3

-4

-4

-5

-5

Percent

0

-6

-6

Q1

Q3 00

Q1

Q3 01

Q1

Q3 02

Q1

Q3 03

Q1

Q3 04

Q1

Q3 05

Q1

Q3 06

Q1

Q3 07

Q1

Q3 08

Q1

Q3 09

Source: Reuters EcoWin

Result ‐ trend growth will be weaker UK - Potential GDP and Trend Growth

Percent

Source: OECD World Economic Outlook 3.50

3.50

3.25

3.25

3.00

3.00

2.75

2.75

2.50

2.50

2.25

2.25

2.00

2.00

1.75 1.50

1.75 Estimated UK Trend Growth Rate

1.50

1.25

1.25

1.00

1.00

1.4

1.4

1.3

1.2

1.2

1.1

1.1

1.0

1.0

0.9

0.9

0.8

thousand billiions

Real GDP (thousan nd billions)

Potential GDP 1.3

0.8 90

91

92

93

94

95

96

97

98

99

00

01

02

03

04

05

06

07

08

09

10

11

Source: OECD World Economic Outlook

18

3/26/2010

With implications for government finances Net Government Debt and UK Budget Surplus/Deficit 65

65 Net UK government debt as % of GDP

60

60

55

55

50

50

45

45

40

40

35

35

30

30

20

20 Public sector finances - surplus on current budget £bn per month

15

15

10

10

5

5

0

0

-5

-5

-10

-10

-15

-15

-20

-20 Jan

Apr

Jul 05

Oct

Jan

Apr

Jul 06

Oct

Jan

Apr

Jul 07

Oct

Jan

Apr

Jul 08

Oct

Jan

Apr

Jul 09

Oct

Jan

Apr

Jul Oct 10 Source: Reuters EcoWin

The UK is running a huge structural deficit UK Government Borrowing Borrowing as a percentage of GDP, data for 2010-11 is a forecast from the OECD 8.0

8.0

6.0

6.0

4.0

4.0 Government borrowing

2.0

2.0 Cyclically adjusted borrowing

0.0

0.0

-2.0

-2.0

-4.0

-4.0

-6.0

-6.0

-8.0

-8.0

-10.0

-10.0

-12.0

-12.0

-14.0

-14.0

-16.0

-16.0 90

91

92

93

94

95

96

97

98

99

00

01

02

03

04

05

06

07

08

09

10

11

Source: OECD World Economic Outlook

19

3/26/2010

A deliberate (and large) Keynesian stimulus UK Government Spending and Taxation Measured as a percentage of national income (09-10 is a forecast from the OECD)

55.0

55.0

52.5

52.5

50.0

50.0

47.5

47.5

Total Government Spending 45.0

45.0

42.5

42.5

Total Tax Revenue 40.0

40.0

37.5

37.5

35.0

35.0

90

91

92

93

94

95

96

97

98

99

00

01

02

03

04

05

06

07

08

09

10

Source: OECD World Economic Outlook

Risks and uncertainties We are reaching a turning point in  th i l b t th bi the economic cycle but there are big  risks and uncertainties ahead

20

3/26/2010

Risks in 2010 – External Headwinds • Further external shocks – Stalled recoveries in major  trading partners di – New wave of financial  distress e.g. Dubai sovereign  debt and Greek crisis – Surge in commodity prices  e.g. Oil, gas, metals,  foodstuffs – Sudden depreciation of the  US dollar (drives sterling up)

Where next for world oil prices? World Crude Oil Price - US Dollars Per Barrel

US dollars per barrel

US dollars

150

150

140

140

130

130

120

120

110

110

100

100

90

90

80

80

70

70

60

60

50

50

40

40

30

30

20

20

10

10

0 Jan

0

May

Sep 04

Jan

May

Sep 05

Jan

May

Sep 06

Jan

May

Sep 07

Jan

May

Sep 08

Jan

May

Sep 09

Jan 10

Source: Reuters EcoWin

21

3/26/2010

Will commodities create fresh inflation? The Economist Commodity Price Index Index of Prices 2000=100 325

325

300

300 Industrial Metals

275

250

250

225

225

Index

275

All Commodities 200

200

175

175

150

150

125

125

Food

100

100 04

05

06

07

08

09

10

Source: Economist Commodity Price Index

Three of the BRICs power ahead BRICS v UK: Annual Growth of Real Gross Domestic Product Annual % change in GDP at Constant Prices 15.0

15.0

12.5

12.5 India

10.0

10.0 China

7.5

7.5 Russia

5.0

5.0

2.5

2.5 UK

0.0

0.0 Brazil

-2.5

-2.5

-5.0

-5.0

-7.5

-7.5

-10.0

-10.0

-12.5

-12.5 Q1

Q3 00

Q1

Q3 01

Q1

Q3 02

Q1

Q3 03

Q1

Q3 04

Q1

Q3 05

Q1

Q3 06

Q1

Q3 07

Q1

Q3 08

Q1 Q3 09 Source: Reuters EcoWin

22

3/26/2010

Risks in 2010: Domestic UK fragility • Fragility of the UK economy – – – – – –

Eye watering fiscal deficit will require a squeeze on G&T Worries that UK government will lose AAA credit rating Worries of capital flight  / sterling weakness Counter‐risk – rising £ might choke export recovery Huge level of household debt left to be repaid Many corporate bonds due for repayment in 2010

The new normal • ‘New normal’ will be slower  growth and a decade of fiscal  austerity • Permanent loss of output  because of recession – hysteresis effects are  becoming clearer • Your generation will pay for  the excesses and failures of  the present generation

23

3/26/2010

Tutor2u Keep up‐to‐date with economics,  resources quizzes and resources, quizzes and  worksheets for your economics  course.  

Corporate Bond Yields Spread of Yields on Corporate Debt, % 9

9

8

8

7

7

6

6

5

5

4

4

3 Jan

3 Mar A Rated

May

Jul Sep 07 AA Rated

Nov

Jan

AAA Rated

Mar

May

Jul 08

Sep

Nov

Jan

Mar

May

Jul 09

Sep

Nov

Jan

Mar 10

BBB Rated Source: Reuters EcoWin

24

3/26/2010

US growth and jobs United States Unemployment and GDP Growth Unemployment (top pane), Real GDP (Bottom Pane) 10

10

9

9

8

8

7

7

6

6

5

5

4

4

3

3

14

14

13

13

12

12

11

11

10

10

9

9

8

8

7

7 88

89

90

91

92

93

94

95

96

97

98

99

00

01

02

03

04

05

06

07

08

09

Source: Reuters EcoWin

Car scrappage has worked but comes to an end Annual percentage change in new car registrations Annual % change for the UK 60

60

50

50

40

40

30

30

20

20

10

10

0

0

-10

-10

-20

-20

-30

-30

-40

-40 Jan

Mar

May

Jul 06

Sep

Nov

Jan

Mar

May

Jul 07

Sep

Nov

Jan

Mar

May

Jul 08

Sep

Nov

Jan

Mar

May

Jul 09

Sep

Nov

Jan 10

Source: Reuters EcoWin

25

3/26/2010

Long term decline in oil and gas output Extraction of Oil & Gas in the UK 150

140

140

130

130

120

120

110

110

100

100

90

90

80

80

70

millions

2005=100 (millions)

Index of output, 2001=100, seasonally adjusted data 150

70 97

98

99

00

01

02

03

04

05

06

07

08

09

10

Source: Reuters EcoWin

UK trade deficit and sterling index UK Trade & the Sterling Exchange Rate Quarterly trade balance, £ billion (bottom pane) and exchange rate index (top pane)

105

105

100

100

95

95

90

90

85

85

80

80

75

75

70

70

0.0

0.0

-2.5

-2.5

-5.0 50

-5.0 50

-7.5

-7.5

-10.0

-10.0

-12.5

-12.5

-15.0

-15.0

90

91

92

93

94

Effective Exchange Rate Index

95

96

97

98

99

00

01

02

03

04

05

06

07

08

09

Balance of Trade in Goods and Services Source: Reuters EcoWin

26