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UK Economics & Market Outlook
Ian Stewart
+44 20 7996 1512
Dec
ember
2001
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l US, German and Japanese recessions underway; UK avoids recession
l Surveys provide only tentative evidence that the UK domestic economy is cooling
l Rate lows: US 1.5%; Eurz 2.75%; UK 3.5%
l Monetary policy works . . . strong 2002H2 recovery
l Buy UK domestic consumer plays
l Downside risks: US imbalances, Japanese banks, ECB inertia
Overview
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
0
0.50
1.00
1.50
2.00
2.50
3.00
3.50 3
4
5
6
7
8
9
10
11
Base Rates Lead UK Consensus Growth Forecasts
Falling rates implyrisinggrowthforecasts
Consensus forecasts forUK GDP growth
Base rates, invertedand pushed forward
6 months (RHS)
Rolling average for current & next years consensus GDPforecasts for the UK (LHS)Base rate plot inverted and pushed forward 6 months (RHS)
Ba
se
rates
falling
ML Forecasts (Consensus)
2000 2001F 2002F
GDP Growth 3.0 2.3 (2.1) 2.2 (2.0)
RPIX inflation, end year 2.1 2.0 (2.2) 2.5 (2.4)
Base rates, end year 6.0 4.0 5.010 year yields, end year 4.9 4.7 5.0
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J F M A M J J A S O N D J
180
200
220
240
260
280
300
J F M A M J J A S O N D J
180
185
190
195
200
205
210
215
220
225
230
235
Markets Believe This is a Recovery
Commodity PricesCRB IndexCyclicals vs DefensiveStocks (UK)
2000
Total returns: cyclicals / defensivesCyclicals = Mining, basic industries, generalindustries, cyclical consumer goodsDefensives = Utilities, food retailing, non-cyclicalconsumer goods
2001J F M A M J J A S O N D J
4.30
4.40
4.50
4.60
4.70
4.80
4.90
5.00
5.10
5.20
5.30
5.40
10 Year Bond Yield
2000 2001 2000 2001
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The Feds Problem
1995 1996 1997 1998 1999 2000 2001
1
2
3
4
5
6
7
8
Fedfunds
US Short Rates, Long Rates
30 yearbonds
Laurence Meyer, 27.11.01:
On the US outlook prior to 11th September:I expected growth to build only slowly and thereforeexpected the pace of recovery through the first half of 2002to be disappointing.
The response of financial conditions to monetary policyeasing in this episode has been unusual, if not unique...[dueto weakness in equities and dollar strength]...I believe thatthe financial shocks that have occured - including theshocks to equity prices and the dollar - have requiredmonetary policy to move more aggresively than wouldotherwise have been the case.
The implication of starting with an unusually low interest rateis therefore not to go slowly but to be respond moreaggressively to any adverse shock
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11th September Collapses Growth Forecasts
89 90 91 92 93 94 95 96 97 98 99 00 01 02
0.50
1.00
1.50
2.00
2.50
3.00
3.50
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
0
500
1000
1500
2000
2500
3000
3500
4000
4500
UK press and newswire references to the word recession
Recession Newsflow G7 GDP Growth Forecasts
12 month rolling consensus forecasts for G7 GDP growth
Consensus Forecasts for 2002 GDP Growth in:
Jan-01 Nov-01 ChangeNov as %
of Jan
US 3.5 0.7 2.8 20
Japan 1.9 -0.6 2.5 -32
Asia Pacific 3.2 1.0 2.2 31
Latin America 4.1 1.9 2.2 46
Eurozone 2.4 1.5 0.9 63
UK 2.6 2.0 0.6 77
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Traditional Ingredients for Post-War Recession =Collapsing Optimism + Rising Inflation
Manufacturingconfidence
2.5% Inflation Target (RHS)
= Recession
= No Recession
Inflation (RHS)
UK
US
NAPM
Inflation (RHS)
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02
-120
-100
-80
-60
-40
-20
0
20
40
50
0
10
20
30
40
50
60
70
1. Inflationary excess (UK 1990-2)
2. Structure imbalances and
failures (Japan 1990s)
3. Policy mistakes (Japan, GreatDepression)
Why Recessions Happen:
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02
0
10
20
30
40
50
60
70
80
0
5
10
15
20
25
30
35
40
45
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1998 1999 2000 2001 2002
50
100
150
200
250
300
350
1. Collapsing Equity Prices
TMT
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
1
2
3
4
5
6
7
8
9
1
2
3
4
5
6
7
8
9
NominalTotal Market
72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02
0
10
20
30
40
50
60
70
US
2. Surge in the Oil Price 3. 1999-2000 Rate Hikes
Real
Why Has the US Surprised on the Downside?
Euroland
January 1998 = 100
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Why This Slowdown is Different . . . To a Certain Extent
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02
-30
-20
-10
0
10
20
30
40
50
-2
-1
0
1
2
3
4
5
6
7
8
Capex(LHS)
Householdspending(RHS)
Its Been Driven by Capex . . . . . . And This Has Occured DespiteMassive Rate Cuts
= Recession
60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02
-8
-6
-4
-2
0
2
4
6
8
10
12
25
30
35
40
45
50
55
60
65
70
75
Real moneygrowth
NAPMsurvey
US capex & household spending: % change over 4 quarters
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Japanese GDP Growth
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
-3
-2
-1
0
1
2
3
4
5
6
7
8
Natural Disasters Do Not Cause Recessions
January 1995Kobe earthquake
US Natural Disasters
Cost, $Bn As % US GDP
Hurricane Hugo 1989Q3 17.8 0.2%
Hurricane Andrew 1992Q3 63.9 0.6%Northridge Earthquake 1994Q4 74.8 0.7%
11th September Attacks 2001Q3 14.0* 0.1%
UCLAestimate
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88 89 90 91 92 93 94 95 96 97 98 99 00 01 02
40
50
60
70
80
90
100
110
120
130
140
86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03
1
2
3
4
5
6
7
8
86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03
-2
-1
0
1
2
3
4
5
6
86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01
80
100
120
140
160
180
200
220
Japan & US - Differences
Real Estate Prices1986 = 100
Unemployment, %
Real rates high
in 1990-91
US
US
Real Interest Rates
Unemploymentunchanged1990-92
Japan
US
Japan
US & Japanese Banks sector relative1988 = 100
Banks vs Their Broad Market
Japan
US
Japan
DIFFERENT
DIFFERENT
DIFFERENT
DIFFERENT
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l Money
l Fiscal policy
l Inventories
l Market sentiment
l Low expectations
US Outlook
Bull Case
l Capex
l Debt and savings
l Asset prices
l Unemployment
Bear Case
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13
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
-10
-5
0
5
10
15
Australia
How Did Australia Manage toWeather the Asian Crisis?
Crisis starts
1993 1994 1995 1996 1997 1998 1999 2000 2001
4.00
4.50
5.00
5.50
6.00
6.50
7.00
7.50
8.00
65
70
75
80
85
90
95
100
105
Korea
With Massive Monetary Ease
Australia: Monetary Policy in Action
Rates
Aus $
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14
1998 1999 2000 2001
-15
-10
-5
0
5
10
15
Recessions Require Consumer Capitulation
ExportsCapex
ConsumerspendingRecessions Since 1970
Manufacturing 10
Profits 10
Capex 6
GDP 3Profits
Manufacturing
Components of UK GDP% change yoy
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15
80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01
-6
-4
-2
0
2
4
6
8
Why Has the UK Consumer Held Up?
Nominal earnings deflated by the Tax and Price Index
1. BoE activism: base rate cuts.Down at least 200bp this year.
2. Lower taxes. Down by 9.0bnin April 01, equivalent to 3p offthe basic rate.
3. Windfall gains: 1bn fromFriends Provident; 1.5bn fromScottish Life; all due in 2001H2
Real, Post Tax Earnings Growth
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16
1 99 0 1 99 1 1 99 2 1 99 3 1 99 4 1 99 5 1 99 6 1 99 7 1 99 8 1 99 9 2 00 0 2 00 1
-30
-20
-10
0
10
20
30
40
-30
-20
-10
0
10
20
30
40
1 99 0 1 99 1 1 99 2 1 99 3 1 99 4 1 99 5 1 99 6 1 99 7 1 99 8 1 99 9 2 00 0 2 00 1
-6
-4
-2
0
2
4
6
8
10
12
-6
-4
-2
0
2
4
6
8
10
12
1 99 0 1 99 1 1 99 2 1 99 3 1 99 4 1 99 5 1 99 6 1 99 7 1 99 8 1 99 9 2 00 0 2 00 1
-600
-500
-400
-300
-200
-100
0
100
200
300
400
-600
-500
-400
-300
-200
-100
0
100
200
300
400
1 99 0 1 99 1 1 99 2 1 99 3 1 99 4 1 99 5 1 99 6 1 99 7 1 99 8 1 99 9 2 00 0 2 00 1
-60
-50
-40
-30
-20
-10
0
10
20
30
40
-60
-50
-40
-30
-20
-10
0
10
20
30
40
1 99 0 1 99 1 1 99 2 1 99 3 1 99 4 1 99 5 1 99 6 1 99 7 1 99 8 1 99 9 2 00 0 2 00 1
0
1
2
3
4
5
6
7
8
9
10
11
0
1
2
3
4
5
6
7
8
9
10
11
UK Leading Indicators
CBI Business Confidence
Real Broad Money GrowthSlope of the Yield Curve
Chambers Survey: Orders
1 99 0 1 99 1 1 99 2 1 99 3 1 99 4 1 99 5 1 99 6 1 99 7 1 99 8 1 99 9 2 00 0 2 00 1
-35
-30
-25
-20
-15
-10
-5
0
5
10
-35
-30
-25
-20
-15
-10
-5
0
5
10
Consumer Confidence
OECD Leading Indicator
-ve
forcorporates
+ve
for
consumer
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1 991 1 992 1 99 3 1 99 4 1 99 5 1 99 6 19 97 1 998 1 999 2 000 2 00 1
-30
-20
-10
0
10
20
30
40
7 8 7 9 8 0 8 1 8 2 8 3 8 4 8 5 8 6 8 7 8 8 8 9 9 0 9 1 9 2 9 3 9 4 9 5 9 6 9 7 9 8 9 9 0 0 0 1
-20
-15
-10
-5
0
5
10
15
20
25
30
90 91 92 93 94 95 96 97 98 99 00 01 02
-35
-30
-25
-20
-15
-10
-5
0
5
10
-60
-50
-40
-30
-20
-10
0
10
20
30
1 99 0 1 99 1 1 99 2 1 99 3 1 99 4 1 99 5 1 99 6 1 99 7 1 99 8 1 99 9 2 00 0 2 00 1
-80
-60
-40
-20
0
20
40
60
80
1997 1998 1999 2000 2001 2002
-5
0
5
10
15
20
25
1
2
3
4
5
6
7
Consumer Expenditure Scorecard:
Expenditure Strong, Only Tentative Signs of Softening
RICS Price Balance& Housing Reservations
Retail Sales:
John Lewis vs Official DataConsumer Confidence
Number of Mortgage Approvals
Car Sales:
% Change 3m/12m
Manpower Survey:Recruitment Intentions
GfK
GfK: Based on answers to 5 questions on the outlook/
performance of the economy/own households finances &
willingness to make big ticket purchases
MORI: Economic Optimism
MORI
3m/12m
HBF
RICS
2001
JohnLewis
Retail salesvolumes(RHS)
Number of mortgage approvals after cancellationsand remortgaging
Balance of housebuilders from monthly HBF surveyreporting an increase in:
House Prices, nsaPurchasers making an initial deposit (reservation)on a new house, nsa
2000John Lewis weekly retail sales: 6 week movingaverage
3m/3m
Balance of employers in all sectors planning toraise employment
October:+21.7%
J F M A M J J A S O N D J F M A M J J A S O N D
-10
-5
0
5
10
15
20
25
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Consumer Output Scorecard:
Service Firms More Bearish
1993 1994 1995 1996 1997 1998 1999 2000 2001
-80
-60
-40
-20
0
20
40
60
80
1997 1998 1999 2000 2001
35
40
45
50
55
60
65
70
75
Services
Businessservices (10%)
New Orders Business Optimism in the Service SectorCBI Survey Data
Balance of firms expressing greater optimism about the economic situation
Financialservices (6%)
Consumerservices (10%)
Retail (12%)
Orders falling Manufacturing
Construction
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19
72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04
3
4
5
6
7
8
9
10
11
0
2
4
6
8
10
12
14
16
18
20
Ultimately, Unemployment Follows the Cycle
Unemployment Follows Rates
US unemployment,rate %
Fed funds,pushedforward 2years (RHS)
US Total Unemployment Rate SADJ
Fed funds rate, pushed forward 2 years (RHS)
1. Adult unemployment.
2. Manufacturing employment.
3. Manufacturing capitalexpenditure.
4.Engineering orders.
5. Manufacturing inventories
Components of ONSLagging Indicator for the UK
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Cyclically Adjusted Public Sector Net Borrowing as a %of GDPChange in Fiscal Stance: (+ve = Fiscal Ease)
00-01 01-02 02-03 03-04 04-05
Nov 99 0 0 +0.3 +0.3 +0.1
Nov 00 +0.8 +0.5 +0.6 +0.8 0
Mar 01 +0.2 +1.1 +0.6 +0.8 0Nov 01 -0.1 +1.9 +0.8 +0.3 -0.2
PBR = Pre-Budget ReportSource: HMTreasury
69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05
-2
-1
0
1
2
3
4
5
6
Fiscal Policy Will Support UK Growth in 2002
Chart shows general Government consumption expenditure, the national
accounts measure of current expenditure which excludes capital spendingand accounts for about 20% of GDPSource: HM Treasury
Government Spending:% Change Year on Year
2.0%
4.75%
The Fiscal Stance
Chart shows the change between fiscal years incyclically adjusted public sectornet borrowing as a share of GDP: This represents the simplest way of showingthe change in the fiscal stance.Source: HM Treasury
Ease:AnthonyBarber
HMTforecasts
Up sharply3.0%
Ease:
JohnMajor Ease:
GordonBrownsplans
Tightening:NormanLamont,Ken Clarke,Gordon Brown
Tightening:Geoffrey Howe
HMTforecasts
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06
-4
-3
-2
-1
0
1
2
3
4
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65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03
54
56
58
60
62
64
66
68
8
9
10
11
12
13
14
15
16
88 89 90 91 92 93 94 95 96 97 98 99 00 01
2.00
2.20
2.40
2.60
2.80
3.00
3.20
3.40
3.60
1.00
1.05
1.10
1.15
1.20
1.25
Debt is a Worry in the UK
The Burden of DebtRatio of Household Expenditure &
Business Investment to GDP
Ratio of gross debt to corporate profits (LHS)
Ratio of gross debt to consumers grossdisposable income (RHS)
Corporates(LHS)
Consumers(RHS)
87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02
5
10
15
20
25
30
35
CorporatesAverage
Income Gearing:Interest Payments as a
% Profits / Income
Interest payments as % of:
Corporates gross profitsConsumers disposable income
AverageBusiness investment
to GDP (RHS)
Household spending
to GDP (LHS)
Consumers
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UK Capital Stock Doesnt Look Overbuilt
Average
Capacity Utilisation
Average
UK (LHS)US (RHS)
US
Average
20 yearlo w
UK
Capital spending hasaccelerated in the UK in
recent years but -unlike the US - there isno clear evidence that
the UK is suffering froman overbuilt capital
stock
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02
0
20
40
60
80
100
120
140
50
55
60
65
70
75
80
85
90
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1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
1.00
1.50
2.00
2.50
3.00
3.50
4.00
4.50
Japan is 2.0%
No Rerating of Long Run Growth Prospects for the UK
Japan was 4.1%
Consensus Estimates for Long Term GDP Growth
UK was 2.6%
Consensus forecasts from Consensus Economics.Figures show for each year and for each country the prevailing consensus forecasts for averageGDP growth rates 5-10 years ahead
US was 2.5%
US is 3.2%
UK is 2.4%
The fall in long runexpectations for Japanese
GDP growth has clearlybeen unhelpful for the
Japanese economy andequity market in recentyears
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UK Inflation - The Best is Past, But Limited Upside Risks
l Inflation boosted March-June by higher petrol & food prices; depressed in September - December by falling
petrol prices
l Goods and utility prices (=33.4% of RPI) have trended up, pushing up core inflation.
l Inflation will benefit from lower output, import and commodity price pressures.
l But we see RPIX inflation edging up to 2.5% by the end of 2002 on firm domestic demand and a tightlabour market.
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1993 1994 1995 1996 1997 1998 1999 2000 2001
0
0.50
1.00
1.50
2.00
2.50
3.00
3.50
4.00
1996 1997 1998 1999 2000 2001 2002
1.40
1.60
1.80
2.00
2.20
2.40
2.60
2.80
3.00
3.20
3.40
HICP
RPIX
RPIX excludingfood & energy
RPIX
Core Inflation Has Troughed Ex-Petrol & Food Inflation Worrisome
Inflation Drivers Changing
2.5% InflationTarget (RHS)
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1996 1997 1998 1999 2000 2001 2002
-2
-1
0
1
2
3
4
5
-15
-10
-5
0
5
10
15
20
1997 1998 1999 2000 2001
-6
-5
-4
-3
-2
-1
0
1
2
3
Goods vs Service Inflation
All Goods(48.8%)
Services(35.8%)
Utility prices
(6.5%)
High street goodsprices (27.1%)
The Changing Composition of Inflation(Weight in RPI Basket)
Two Big Downward Pressures onRPIX Inflation are Receding
(Weight in RPI Basket)
Petrol
(RHS)(4.5%)
Above breakdown excludes mortgage interest payments, Council Tax anddepreciation which accounts for 10.9% of the RPI by weight
Goods prices exclusing food, petrol and tobacco
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70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00
-8
-6
-4
-2
0
2
4
6
8
10
12 1
10
20
30
40
50
55
65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01
-15
-14
-12
-10
-8
-6
-4
-2
0
2
4
5
1
10
20
30
40
50
55
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00
-40
-30
-20
-10
0
10
20
30
40
50
60
1
10
20
30
40
50
55
Big Picture Lead Indicators of Inflation
Labour Market Capacity:Skill Shortages
Whole Economy Capacity:Current Account Deficit
Output gap
Average
Currentaccount
Whole Economy Capacity:Output Gap
Inflation(RHS)
Average
Skills shortages
Inflation(RHS)
Inflation(RHS)
Average
Monetary Policy:House Price Inflation
Average
Housepriceinflation
Inflation(RHS)
60 6 2 6 4 6 6 6 8 7 0 7 2 7 4 76 78 8 0 8 2 8 4 8 6 8 8 9 0 9 2 94 9 6 9 8 0 0
-35
-30
-20
-10
0
10
20
30
40
45
1
10
20
30
40
50
55
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UK Inflation
Inflation forecasts arebelow target
How Much Scope For Downside Surprises on UK Inflation?
1994 1995 1996 1997 1998 1999 2000 2001
1.80
2.00
2.20
2.40
2.60
2.80
3.00
3.20
3.40
3.60
3.80
4.00
1.80
2.00
2.20
2.40
2.60
2.80
3.00
3.20
3.40
3.60
3.80
4.00
98
0299
00
0196
97
95
1993 1994 1995 1996 1997 1998 1999 2000 2001
4.00
4.50
5.00
5.50
6.00
6.50
7.00
7.50
8.00
8.50
9.00
9.50
4.00
4.50
5.00
5.50
6.00
6.50
7.00
7.50
8.00
8.50
9.00
9.50
10 Year Bond YieldsLimiting the scope forpleasant surprises forthe bond market
2.5% inflation target
10
11
90
100
Inflation Expectations & Bond Yields
Barring a hard landinginflation expectations
b bl d t h h
Fund Managersexpectations forinflation
10 year gilt yield
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29
1996 1997 1998 1999 2000 2001
0.40
0.60
0.80
1.00
1.20
1.40
1.60
1.80
2.00
2.20 0.80
0.90
1.00
1.10
1.20
1.30
1.40
81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01
80
85
90
95
100
105
110
115
120
125
130
Outlook
GDP1997
The rebound in in 1996 represented arecovery from post-ERM under-valuation
US/Euroland GDP GrowthForecasts and $/Euro (RHS)
De-rating of Re-rating of
Trade Weighted1990 = 100
GDP1999
GDP1998
GDP2000
US Growth Shock Has Been of SurprisinglySmall Benefit to the Euro
GDP2001
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30/31
30
0
10
20
30
40
50
60
70
80
1975
1977
1980
1983
1987
1990
1991
1992
1993
1994
1996
1997
1998
1999
2000
2001
OUT
IN
EEC Referendum
(67%In; 33% Out)
1999 2000 2001
-60
-50
-40
-30
-20
-10
0
10
20
25
-60
-50
-40
-30
-20
-10
0
10
20
25
The UK & EMU
UK & Danish Attitudes to EMU
Yield Curves: 29th August 1997
UK Guardian / ICM survey: If there were to be a referendum,wouldyou vote to join the Single European Currency, or would youvote not to join?Chart shows % replying join minus % replying not join
% of Voters Who Want toLeave/Stay in the EU
Danish referendum,September 2000 -6%
UKvoters
Danish voters
Yield Curves: 27th November 2001
Source: Bloomberg
Source: Bloomberg
UK
Germany
UK
Germany
7/28/2019 GF2001-IanStewart-UK Eco Market Outlook
31/31
31
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