www.pwc.co.uk/economics
UK Economic Outlook
November 2013
How the services sector is rebalancing Britain’s economy
Consumer spending trends to 2030
Contents1 Summary 04
2 UK economic prospects 07
2.1 Recent developments and the current situation 07
2.2 Economic growth prospects 12
2.3Outlookforinflation 14
2.4Monetaryandfiscalpolicyoptions 16
2.5Summaryandconclusions 17
Box2.1:Whenmighttheunemploymentratefallto7%? 18
3 How the services sector is rebalancing Britain’s economy 20
3.1UKservicesoutputandemploymentovertherecovery 22
3.2 Rebalancing within the services sector 23
3.3ImplicationsforthesustainabilityoftheUKrecovery 25
4 Consumer spending trends to 2030 27
4.1Historicalconsumerspendingtrends 28
4.2Baselineprojectionsforconsumerspendingpatternsto2030 30
4.3Alternativescenarios 31
4.4Implicationsforbusiness 32
4.5Summaryandconclusions 34
Box4.1:Topandbottom10moversinhouseholdspendingsharessince2007 35
Appendices
A Outlookfortheglobaleconomy 36
B UK economic trends: 1979-2012 37
Contacts and Services 38
Highlights and key messages for business and public policy
Figure 1.1: PwC main scenario for output growth by region
Source: PwC analysis
Key projections
2013 2014
Real GDP growth 1.4% 2.4%
Inflation (CPI) 2.7% 2.4%
Source: PwC main scenario projections
• Afteraperiodofgenerallydisappointing growth in 2011 and 2012,theUKeconomyhasshownclearsignsofrecoveryin2013.
• In our main scenario we expect GDP growthtopickupfrom0.1%in2012toaround1.4%in2013andaround2.4%in2014.Riskstogrowtharenow more balanced, with both upside and downside possibilities.
• Non-financialservicessectorswillremain the main engine of growth in bothoutputandemployment,ashasbeenthecaseforthelastfouryears.Ouranalysisalsoshowstheseservicessectorsplayinganincreasinglyimportant role in driving UK export growth.
• We expect London and the South Easttocontinuetoleadtherecovery,but all regions should see stronger growthin2014thanin2013 (see Figure 1.1).
• Consumerpriceinflationislikelytoremainabovetargetataround2.4%in2014,althoughthiswouldrepresentafallfrom2.7%in2013.Therecouldbeupsideriskstoinflationfromanyrenewedriseinglobalcommoditypricesnextyear.
• Persistentlyabovetargetinflationcontributes to a continued decline in real earnings growth in 2013 and 2014,makingsixsuccessiveyears of negative real growth. We would expectagradualrecoveryinrealearnings in 2015-2017, but the level of real earnings in 2017 would nonethelessremainaround6%belowitspeaklevelin2008in our main scenario.
• Subdued real earnings growth should, however, help to keep total UKemploymentgrowingatahealthyrateoverthenextfouryears,despitecontinuedpublicsectorjoblossesover this period.
• Wedonotexpectanyimmediatechangeinmonetarypolicy,withunemploymentnotsettofallto7%until late 2015 in our main scenario. Thisissubjecttomanyuncertainties,however, and it is possible that this threshold could be reached before this, leading to an earlier rise in officialinterestrates.
• Weexpecttoseeagradualrecoveryin consumer spending growth over thenextfewyears,helpedbyrisingincomesfromemploymentandstronger house prices. But continuing upwardpressureonenergyandfoodprices could act as a restraint on growth, as could an eventual rise in interest rates later this decade.
• Takingalongtermview,ouranalysissuggests that the proportion of total consumer spending on housing and utilities,whichisalreadyaround25%,couldrisefurthertoaround30%by2030.Theshareoftotalspending on health and recreation andculturearealsoprojectedtoincrease with an ageing population and rising income levels, but other categoriesofdiscretionaryspendingarelikelytobelessbuoyant.
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4 UK Economic Outlook November 2013
1 – Summary
Recent developmentsTheUKeconomygrewby0.8%in the third quarter of 2013 according topreliminaryestimates,following growthof0.7%inthesecondquarter.ThissuggeststhattheUKrecoveryisnow gathering real momentum after acoupleofsluggishyearsin2011 and 2012.
Growthhasbeendrivenprimarilybyservices, but the latest data from both businesssurveysandofficialsourcesindicate that manufacturing and construction are also now starting to recover.
AcalmersituationintheEurozonehasgenerallysupportedfinancialmarketssincelastautumn,whiletheUSeconomystillseemstobeontheroadtorecoverydespite continued political disagreements overbudgetarymatters.Emergingmarketperformance has been less strong this year,however,withChinesegrowthslowing a little (but remaining fast in absolute terms) and disappointing recentgrowthfiguresfromIndiaandBrazilinparticular.
UKemploymenthascontinuedtorisethisyear,whichhassupportedconsumerspending growth despite persistent negative real earnings growth. Rising houseprices,helpedbygovernmentinitiativessuchasHelptoBuy,havealsosupportedconsumerconfidenceandspending. Business investment has still notpickedupsignificantly,however,reflectingcautionastowhethertherecoverywillprovetobesustainable.Public spending cuts have slowed down, but will remain a drag on growth for manyyearstocome.
Consumerpriceinflation(CPI)hasdrifteddown in recent months, but remains somewayabovetarget.Energyandfoodpricerisescontinuetoweighrelativelyheavilyonlowerincomehouseholds.
Future prospectsAsshowninTable1.1,ourmainscenariois for UK GDP growth to average around 1.4%in2013andaround2.4%in2014.Thisisslightlymoreoptimisticthanthelatestconsensusforecastsfor2014andmuch more optimistic than the OBR wasinMarch,althoughtheseofficialgrowthprojectionsareexpectedtobeincreasedatthetimeoftheAutumnStatement in December.
ConsumerspendinggrowthisprojectedtofollowabroadlysimilarpatterntoGDP,but with somewhat stronger growth this year.Wedonotexpectpositiverealearnings growth to resume until 2015 andeventhenonlyatamodestpace.However,householdincomeswillbesupportedbycontinuedemploymentgrowthandincreasesinnon-employmentincome(notablypensionerbenefits,which remain protected from the government’s spending cuts at least until2015/16).
Investment growth has been disappointing inrecentyears,withthelatestONSestimates suggesting continued subdued capital spending growth during the secondquarterof2013.However,weexpectagradualrecoveryininvestmentovertheremainderofthisyearandinto2014,helpedbyaneasingofgovernmentcapitalspendingcutsandarecovery inhousebuildingactivity.
Netexportsmadeasignificantnegativecontribution to growth in 2012, dragged downinparticularbyweaknessintheEurozone.Wedonotexpectexportstoleadtherecoveryin2013and2014, but their contribution should be more positive.Thisshouldbeassociatedwithsome upturn in manufacturing output in2014aswellasstrongergrowth in services exports as discussed further below.
Asalwaystherearemanyuncertaintiesinherentinourgrowthprojections,asillustratedbythealternativescenariosin Figure 1.2. Risks are now more balanced than before because, although there are still considerable downside risksrelatingtotrendsintheEurozoneandtheglobaleconomymoregenerally,there are also upside possibilities if these problems can be avoided and a virtuouscircleofrisingconfidenceandspending can be established as in past economic recoveries.
Inflationhasremainedstubbornlyabovetargetatanaverageofaround2.7%in2013,whichweexpecttosubsideonlyslightlyto2.4%in2014.Ourmainscenario here is similar to those of the OBR and consensus forecasts shown in Table1.1.Therecouldstillbeupsideriskstothisinflationoutlook,however,ifstrongerglobalgrowthin2014pushesupcommoditypricesagain.
Table 1.1: Summary of UK economic prospects
Indicator (% change on previous year)
OBR forecasts (March 2013)
Independent forecasts (October 2013)
PwC Main scenario (November 2013)
2013 2014 2013 2014 2013 2014
GDP 0.6 1.8 1.3 2.1 1.4 2.4
Consumer spending 0.5 1.6 1.6 1.7 2.0 2.3
CPI 2.8 2.4 2.7 2.4 2.7 2.4
Source: Office for Budget Responsibility (March 2013), HM Treasury survey of independent forecasts (average values in October 2013 survey) and PwC main scenario.
5UK Economic Outlook November 2013
Givenpersistentabovetargetinflationwedonotexpectanysignificantfurthereasingofmonetarypolicyandattentioncouldeventuallyturntohigherinterestrates,althoughpossiblynotuntil2015or later given the new forward guidance regime.Giltyieldshavealreadyrisensignificantlythisyear.
Higherinterestrateswillhelpsaversandreducepensionfunddeficits,butborrowers (including the government) might gain from locking in funding now for long term investments such as infrastructureandhousing.Householdsneedtobearinmindlikelyfutureinterestraterisesinanydecisionsonmortgages or other longer term loans.
Will services continue to lead the recovery?AsdiscussedindetailinSection3,theservices sector has been leading the UK recovery,whilethemuchhoped-forrebalancing towards manufacturing has notyetoccurred.Buttherehasbeenawidediversityofexperiencebetweendifferent activities within the UK services industries. Public administration and financialserviceshavecontractedsignificantlyintermsofoutput and
Figure 1.2: Alternative UK GDP growth scenarios
Source: ONS, PwC scenario
employmentsince2009.Meanwhile,professional, business and support services andthehealthsectorhavegrownstronglyover this period (see Figure 1.3).
Assuch,therebalancingoftheUKeconomyappearstobetakingplaceprimarilywithintheservicessector. Theprivatesectorisexpandingrelativetothepublicsectorandnon-financialservices are growing while the contributionoffinancetooutput andemploymentshrinks.
Mostsignificantly,servicesgrowthseemstobeincreasinglyfocusedonexports.TheUKisthesecondlargestexporter of services in the world behind the US and export-oriented service industries account for at least a third of our GDP1.Thepositivetradebalanceonnon-financialserviceshasdoubled asashareofGDPovertherecovery and the UK is now running a services tradesurplusofaround5%ofGDP.
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Figure 1.3: Growth in UK services output since 2009
Source: ONS
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Education Finance &insurance
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1 Althoughnotalloftheoutputoftheseservicesindustriesisexported.
6 UK Economic Outlook November 2013
Thetradableactivitieswithintheservicesindustriesaregrowingmorestronglythan non-tradables, once allowance is madeforthestructuralfallinfinancialservicesactivity.
Webelievethatthereisnoreasonwhythisservices-ledUKrecoverycannot be sustained, as long as the UK remains a competitive and attractive business locationandmacroeconomicpolicysuccessfullyheadsofffinancialimbalancesandcountersinflationarythreats. Adynamicandflexibleservicessectorthatcancompeteeffectivelyandgrowexport markets is an asset to the UKeconomy.
How will consumer spending patterns evolve?
Theperiodsince2007hasbeenastressfultimeformanyUKhouseholds.Theyhavehad to make tough choices as:
• rentandutilitybillshavetakenupan ever greater proportion of total household budgets; and
• food prices have risen, which is a reversal of historical trends.
Asgrowthresumesandconsumptionstartstopickupoverthenextfewyears,we expect (as discussed in detail in Section4below)that:
• Totalconsumerspendingmightgrowbyaround2%perannuminrealterms on average to 2030, but this couldvaryfromaroundzerorealgrowth for food, clothing and alcohol&tobaccotoaround2.5-3%for housing and utilities, recreation and culture, and health.
“ Consumers are likely to remain highly price-conscious as on-line retailers and high street discount stores continue to take an increasing share of the market”
Figure 1.4: Rising burden of housing and utility costs
Source: ONS, PwC main scenario for 2030
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• Housingandutilitiesnowaccountfor around a quarter of total householdspending,upfromjustover20%beforethefinancialcrisis,andthiscouldrisetoaround30% by2030(seeFigure1.4).
• Spendingonfinancialservices,overseasholidaysandotherdiscretionaryspendinghasbeensqueezedsincethecrisis,butshouldshowsomerecoveryinthelongertermastheeconomypicksup.
• Consumersare,however,likelytoremainhighlyprice-consciousason-line retailers and high street discount stores continue to take an increasing share of the market evenaftertheeconomyrecovers.Retailers will need an effective businessstrategyforthedigitalage.
7UK Economic Outlook November 2013
2 – UK Economic prospects
Key points• TheUKhasbeguntoshowconsistentsignsofrecoverywithgrowthof0.8%inQ32013onthebackof0.7%growth in the preceding quarter. Future growth expectations have also picked up as business and consumerconfidencehasriseninrecent months.
• Services sector activities are leading theway,butlatestdataalsoshowsignsofrecoveryinmanufacturingand construction that we would expect tostrengthenfurtherthrough2014.
• Consumer spending has recovered this year,supportedbyrisingemployment and a stronger housing market. Businessinvestmenthasyettopickupsignificantly,butshoulddosoin2014ifdemandcontinuestostrengthenandtherearenomajorglobalshocks.
• InflationremainsstubbornlyabovetheBankofEngland’s2%targetat2.7%intheyeartoSeptember2013.In our main scenario, we expect some declineto2.4%in2014,butupsiderisksremainfromglobalcommodityprices.Realearningsgrowthislikelytoremainnegativein2013-2014, but could return to modest positive growth from 2015.
• WeprojectGDPgrowthfortheUKasawholetobearound1.4%in2013,gatheringpacetoaround2.4%in2014.Allregionsshouldseestrongergrowthnextyear,ledbyLondon.Downside risks remain in relation to the global environment, but there are also upside possibilities if business investment picks up faster thanprojectedinourmainscenario.
IntroductionIn this section of the report we describe recentdevelopmentsintheUKeconomyand review future prospects. Thediscussioncovers:
2.1 Recent developments and the present situation
2.2 Economic growth prospects: national, sectoral and regional
2.3 Outlookforinflation
2.4 Monetaryandfiscalpolicyoptions
2.5 Summaryandconclusions
2.1 – Recent developments and the present situation
The UK economy grew by 0.8% in the third quarter of 2013 according to preliminary estimates, building on the 0.7% increase in the second quarter of the year. Domesticdemandwas0.7%higher inrealtermsinQ22013thanin the corresponding quarter in 2012 (seeFigure2.1).Althoughpositive,thisis still sluggish compared to pre-recession norms, as real domestic demand growth averagedaround3.5%perannumbetween1998and20071. But this growthrateislikelytohavepicked up in the third quarter2.
Figure 2.1: Growth in the expenditure components of GDP in both real and nominal terms in Q2 2013 relative to Q2 2012
Source: ONS
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1 InflationReport,BankofEngland,8May2013.2 Q32013dataontheexpenditurecomponentsofGDPwasnotavailableatthetimeofpublication,butretailsalesdatasuggeststhatconsumerspendingstrengthened furtherinthatquarter.StrongerconstructiondataalsosuggestsariseincapitalspendinginQ32013,althoughthisremainstobeconfirmed.
8 UK Economic Outlook November 2013
Different components of domestic demandhaveshownverydifferenttrends, however, with consumer spendingleadingthewaywhileinvestmentdeclinedsharplyovertheyeartoQ22013asawhole(althoughtotalfixedinvestmentgrowthreturnedtomodestlypositiveterritoryinthesecond quarter when compared to the firstquarterof2013,andmaywellhaverisen further in the third quarter given strong estimated growth in construction output in that period).
Relativelymodestdomesticdemandgrowth has, however, kept import growth under control, whereas exports showed a stronger trend in the second quarter.Thisperformanceisparticularlyimpressive given lethargic demand in theEurozoneareaandvolatilecurrencymovementsinmanyemergingmarketeconomies.However,tradefigurescanbe erratic and latest data suggest a renewedwideningoftheUKtradedeficitinJulyandAugust,perhapsreflectingstronger domestic demand in that period and an emerging market slowdown.
General government consumption continued to grow in the second quarter of 2013, but this trend is not expected
Figure 2.2: Sectoral output growth in year to Q3 2013
Source: ONS
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Construction Distribution,hotels &
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Utilities Mining &quarrying
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Figure 2.3: Change in employment by industry since the recession (Q4 2009 - Q2 2013)
Source: ONS
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Education Arts,entertainment& recreation
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Information &communication
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activities
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& technicalactivities
Humanhealth
& socialwork
activities
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activities
tolastinthemediumtermasthefiscalausterityprogrammecontinues.Inthe2013/14and2014/15periodshowever,the pace of public spending cuts is being slowed down prior to a planned renewed accelerationincutsfrom2015/2016,asset out in the Spending Review in June.
Growth starting to spread from services to other industry sectorsFigure 2.2 shows that growth in the manufacturing sector has now recorded positive albeit modest growth in the yeartothethirdofquarterof2013.
Thisinanimprovedperformancecompared to previous quarters where manufacturing was shrinking on a year-on-yearbasis...Moreimpressivethough is the turnaround of construction, whichhasreboundedfrompreviouslyweakperformancetogrowbyaround5%comparedtothethirdquarterof2012(althoughtheseareonlypreliminaryestimates that could well be revised significantlylater).
9UK Economic Outlook November 2013
Nonetheless,theUKrecoveryhaspredominantlybeenledbytheservicessector, which now accounts for around 80%oftotalUKGDP.Growthinbusinessservicesandfinanceoutputwas2.1%intheyeartoQ32013,whiledistribution, hotels and restaurants recordedparticularlyrapidgrowthof3.8%.Trendsandprospectsfortheservices sector are discussed in more detail in Section 3 of this report.
ThepredominantroleofservicesisreinforcedbythedatainFigure2.3,whichshowthechangesinemploymentacrosskeysectorsovertheperiodsincetherecovery(inemployment)beganinQ42009.Thishasbeendistributedunevenlyacrosssectors,withgrowthbeingheavilyfocusedonprivatesectorservices,andthelargestemploymentdeclines being seen in construction and publicadministration.Thelatterreflectsthe fact that government cuts have focusedparticularlyonlocalgovernment,while areas such as health and education havebeenlargelyprotected.Again,these trends are explored in more detail in Section 3 below.
Other important indicators of the latest sectoral trends are suggesting that a broaderbasedrecoverymaynowbeunderway.Inparticular,theCIPS/MarkitPurchasingManagersIndices(PMIs),whichcanbeseeninFigure2.4,havebeenstronglypositive(indicatedbyaPMIscorewellabove50)forseveralmonths in a row now for manufacturing aswellasservices.TheconstructionPMI,notshowninthechart,hasalsomovedstronglyintopositiveterritory inrecentmonths,ledbyarecoveryinhousebuilding.
Are the good times returning for consumers?ThelatestONSestimatesshowthathousehold consumption expenditure has risen in real terms for seven consecutive quarterssincetheendof2011.Thisisdespitehighlevelsofinflationandassociated negative real earnings growth (see Figure 2.5). One factor helping to sustain this has been savings ratios declines since 2009.
Therealearningssqueezeeasedsomewhat during the course of 2012, but has become more marked again during2013asconsumerpriceinflationhasremainedstubbornlyaboveits2%target while nominal earnings growth hasfallenbacktobelow1%.
Figure 2.4: Purchasing Managers’ Indices of business activity
Source: CIPS/Markit
Figure 2.5: Real earnings growth (relative to CPI)
Source: ONS (defined as average earnings growth less CPI inflation rate)
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10 UK Economic Outlook November 2013
Figure2.6breaksdowninflationsincethe recession into its subcomponents to see which goods or services having been drivingabovetargetinflationrates. Aswemightexpectduetothedutiesplaced on these goods, alcohol and tobaccopriceshaverisensharply. Moresurprisingperhapsisthatthefastestgrowingpricecategoryhasbeeneducation.Thisisattributabletorisingfeesatprivateschoolsandtheuniversitytuition fee increases that occurred from September 2012.
PwCanalysis3 has shown that, excluding this exceptional rise in education costs, the rise in the cost of staple goods such asfoodandgas,electricityandwaterbills has meant that the poorest income groupshavebeenhitthehardestbyrecentpricerises.Anotherareathathasseen steep average price rises since 2009 hasbeentransport;thisreflectstherising cost of air travel as well as increases in petrol prices over the pastfouryears.
Figure 2.6: Average annual inflation rate since January 2009, by broad spending category within CPI
Source: ONS
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Total Health Miscellaneousgoods & services
Housing,water, electricity,
gas & otherfuels
Recreation& culture
Clothing& footwear
3 http://pwc.blogs.com/economics_in_business/2012/11/inflation-hits-richest-and-poorest-hardest.html 4 BasedontheLFSmeasureofunemployment.
Despitethecombinationofhighinflationand low nominal earnings growth, consumerspendinghasbeenrelativelyresilientoverthepastfewyearswithparticularlystrongtrendsinrecentmonths. For example, retail sales in September2013were2.2%higherthanayearearlier.Furthermore,quarteronquarter,thequantityofgoodsboughtroseby1.5%inQ32013,whichwas the largest quarter on quarter increase since2008.
One important driver here seems to be that house prices have been on the rise, following a period of relative stagnation in2011and2012.Assistancebygovernment in the form of schemes such asHelptoBuyandFundingforLendinghave helped to boost mortgage approvals andhousepricesthisyear.Figure2.7shows nominal house prices rises over thelastyearbyregionandcomparesthemtoCPIinflationoverthesameperiod. We can see that London is where prices are rising fastest, but prices have declinedslightlyinScotlandandbeenbroadlyflatintheNorthEastandNorthern Ireland. So, at least outside London, talk of a new house price bubble seems premature.
Anotherkeyaspectoftherecoverywhich has reinforced household spending has been the continued resilience of the labour market in recent yearsdespitelacklustreoutputgrowthin2011and2012.Theunemploymentratefellagainto7.7%oftheworkingage labour force in the three months to August20134, while the claimant count fell to 1.35m in September, a level not seensinceearly2009.Theunemploymentrate and its relationship with the new forward guidance rules of the Bank of England are discussed in more detail in Box 2.1.
Akeydriverofstrongemploymentgrowth has been the fall in real earnings showninFigure2.6above.Thishashelpedtopricepeopleintojobs,whichhascushionedtheoverallemploymentimpactofthefinancialcrisis.Thisinturnhaslimitedthelossofemployment-related skills and demonstrated the UKlabourmarket’sflexibility.
11UK Economic Outlook November 2013
Is investment about to make a comeback?Investmentalwaystendstobeoneofthe most volatile components of GDP and,afterfallingverysharplyduringtherecessionof2008-9,businessinvestmenthasexperiencedonlyamodestrecoverysincethen.Therehasbeen a marked contrast between the generallybullishpathofequitymarkets(seeFigure2.8)andrelativelysubdued
investment levels. Indicators such as PMIsarenowlookingmorepositiveasdiscussed above, but this momentum hasyettofeedthroughsignificantlyintorealinvestmentactivity.
Part of the reason for this caution has been constrained lending conditions, particularlyforsmallandmedium-sizedbusinesses, as banks seek to recapitalise andadjusttotoughernewregulatoryregimes.Moreimportantly,however,
considerableuncertaintystillhangsovermanyaspectsoftheglobaleconomicenvironmentfromtheEurozoneandtheMiddleEasttoemergingmarketwobblesthisyearandwranglesoverUSfiscalpolicy.Althoughsomeoftheseuncertaintieshavereduced,notably asregardstheEurozone,theoverallenvironment for investment remains challengingatthisearlystagein therecovery.
Figure 2.7: % Change in house prices by region (Q2 2012 – Q2 2013)
Source: ONS
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Figure 2.8: Equity market indices
Source: Thomson Reuters
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12 UK Economic Outlook November 2013
2.2 – Economic growth prospects: national, sectoral and regionalWe expect the upward trajectory in the UK economy seen so far this year to continue into 2014. Inourmainscenario,weprojectaveragerealGDPgrowthofaround1.4%in2013,pickinguptoaround2.4%in 2014(seeTable2.1).TheseGDPgrowthprojectionshavebeenrevisedupwardsfrom those we made in our last UK EconomicOutlookreportinJuly5, reflectingthegenerallypositivedatathathave been released in recent months.
OurprojectionsinTable2.1alsoenvisagearecoveryinconsumerspendinggrowth.Thisisinlinewithourexpectationsofmoderatinginflationfrommid-2014onwards, which should help to ease some of the pressures on real disposable incomes. Longer term prospects for consumer spending are discussed in moredetailinSection4below.
SinceJuly,wehaverevisedourfixedinvestmentprojectionstobesomewhatmore positive, anticipating less of a decline in 2013 and a stronger rebound in2014.Thisreflectsrecentmorepositive sentiments about the UK economymoregenerally.
Table 2.1: PwC main scenario for UK growth and inflation
(% real growth unless stated) 2012 2013 2014
GDP 0.1% 1.4% 2.4%
Consumer spending6 1.2% 2.0% 2.3%
Government consumption 1.7% 0.4% 0.9%
Fixed investment 0.9% -2.8% 4.1%
Domestic demand 1.0% 1.0% 2.2%
Net exports (contribution to GDP growth) -0.7% 0.2% 0.1%
CPI (%: annual average) 2.8% 2.7% 2.4%
Source: ONS for 2012, PwC main scenario for 2013-14.
5 InthatreportweprojectedUKGDPgrowthofaround1%in2013and2%in2014,slightlyabovetheconsensusforecastsatthetime. 6 Wedefinethisashouseholdconsumptionexpenditurenotincludingconsumptionbynot-for-profitinstitutionsservinghouseholds,suchaspensionfunds and life insurance companies.
Table 2.2: Official and independent forecasts
(% real YoY growth unless stated)
Latest estimates
OBR forecasts (March 2013)
Average independent forecast (Oct 2013)
2012 2013 2014 2013 2014
GDP 0.1% 0.6% 1.8% 1.4% 2.2%
Manufacturing output -1.7% N/A N/A -0.2 2.1%
Consumer spending 1.2% 0.5% 1.2% 1.7% 1.8%
Fixed investment 0.9% 2.2% 6.7% -2.3% 5.5%
Government consumption 1.7% 0.4% -0.7% 0.8% -0.2%
Domestic demand 1.0% 0.5% 1.6% 0.9% 1.9%
Exports 1.0% 1.5% 4.4% 2.1% 4.2%
Imports 3.1% 1.0% 3.8% 0.9% 3.5%
Current account (£ bn) -60 -44 -36 -52 -43
Unemployment claimant count (Q4 m) 1.59 1.6 1.6 1.42 1.33
Source: ONS for 2012, OBR Economic and Fiscal Outlook (March 2013), HM Treasury survey of independent forecasts (October 2013)
13UK Economic Outlook November 2013
Net exports are also expected to contributepositivelytoGDPgrowthin2013and2014,reversingthedeclineseenin2012.Thiswillbedrivenbyglobal macroeconomic conditions graduallyimprovinginourmainscenario(seeAppendixAformoredetailsoftheseglobalprojections).Butwearenotanticipating strong export-led growth given continued difficulties in the Eurozone;inlinewithhistoricaltrends,domesticdemandwillremaintheprimarydriverofUKgrowthinbothyears
ComparingTables2.1and2.2,ourlatestGDPprojectionsaremoreoptimisticthanthoseoftheOBRmadeinMarch,butbroadlyinlinewiththeaverageoftheindependentforecastssurveyedbytheTreasuryinOctober.Thedifferencesbetween these latest sets of forecasts andtheOBR’sassessmentinMarchreflecttheshiftsincetheninattitudestowardstheprospectsfortheUKeconomy.We have moved from a discussion of a possible renewed recession to a discussion about how robust we can expecttheUKrecoverytobe.
Uncertaintyremainsakeythemewhenconsidering future prospects for the UK economyand,toaccountforthis,wehave considered two alternative UK growth scenarios alongside our main scenario, as shown in Figure 2.9. We can summarise these as follows:
• Our ‘strong recovery’ scenario sees a rapid rebound in UK growth to an averageofaround4%bytheend of2014.ThisscenarioassumesastrongerrecoveryintheEurozoneoverthenextyearthaninourmainscenario,providingasignificantboost to consumer and business confidenceintheUK.Thisincreasesbusiness investment and consumer spending, as well as external demand for UK exports. Other global economies are also assumed to grow faster in this scenario.
• Our ‘renewed slowdown’ scenario, bycontrast,seesUKgrowthlosingmomentumoverthenextyearduetofurther adverse shocks emanating fromtheEurozone,problemsinemerging markets such as India and Brazil,anddisruptionstooilsupply(leadingtohigherglobalenergyprices) from increased political instabilityintheMiddleEast.TheseriskswouldnegativelyimpactUKbusinesses,damagingconfidenceand forcing cutbacks in investment andemployment,therebyalsodampeningconsumerconfidenceandspending.Thisscenarioisalsolikelytoseeprolongedconstraints in credit markets.
Figure 2.9: Alternative UK GDP growth scenarios
Source: ONS, PwC scenarios
-8
-6
-4
-2
0
2
4
6Projections
Proj
ecte
d %
cha
nge
on a
yea
r ear
lier
Main Prolonged recession Strong recovery
2007Q1
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2010Q1
2011Q1
2012Q1
2013Q1
2014Q1
2015Q1
Althoughwedonotbelievethatthesealternativescenariosarethemostlikelyoutcomes,theycancertainlynotberuled out. Businesses should stress test their business plans against these and other possibilities. Compared to the situationearlierthisyear,however,theupside and downside risks to UK growth now appear to be much more balanced.
Outlook for industry sectors ThesectordashboardinTable2.3showsactualandprojectedoutputgrowthin2012-2014anddrawsoutkeyissues forfivemajorUKindustrysectors.
14 UK Economic Outlook November 2013
All UK regions should see stronger growth in 2014 AsshowninFigure2.10,economicgrowthisnotevenlyspreadacrosstheUK. We anticipate that the slowest growing regionin2014willbeNorthernIreland(1.6%),whileLondonwillagainbe thefastestgrowingarea(2.8%). But all regions should follow the same broadupwardtrendin2013-2014andthe differences between regions are not largerelativetothesignificantmarginsofuncertaintysurroundinganysuchprojections.
2.3 – Outlook for inflationIn our main scenario, we expect inflationontheconsumerpriceindex(CPI)measure,whichiscurrently2.7%,tomoderateslightlyto2.4%in2014,butremain above the Bank of England’s targetof2.0%(seeFigure2.11).
However,duetotheconsiderableuncertainties surrounding this main scenario, we also show two alternative scenarios in Figure 2.11:
• In our ‘high inflation’ scenario, the combinationofsupply-sidepriceshockssuchasanincreaseinenergyand food prices, and a stronger-than-expected rebound in demand, pushes inflationuptoaround3.2%onaveragein2014.
• In the ‘low inflation’ scenario,bycontrast, weak growth in domestic demand, combined with a worsening globaloutlookandflaggingdemandforcommodities,causesUKinflationtofallbackbelowtargetlaterin2014.
Table 2.3: UK sector dashboard
Sector Growth 2012 2013p 2014p Key issues/trends
Manufacturing -1.7% -0.2% 2.6% PMI index is showing strong upward momentum at present, with official figures also turning more positive in Q3 2013
Downside risks to demand in the Eurozone, the UK’s primary goods export market, remain but prospects have improved
Exchange rate volatility, particularly in emerging market currencies, has been high
Construction -7.9% 0.8% 3.2% Housebuilding has shown a strong rebound in recent months which should continue, supported by Help to Buy
Commercial construction also starting to pick up in Q3 2013
Distribution, hotels & restaurants 0.8% 3.8% 3.0% Food price rises are expected to continue
Retail sales volume growth stronger for non-food, where prices have not risen so much
Shift to online sales will continue to put pressure on some high street retailers
Hotels showing sign of upturn in demand
Business services and finance 1.9% 2.0% 3.1% Business services should remain one of the strongest growing UK sectors
The UK financial sector remains exposed to regulatory changes, Eurozone risks and global financial market volatility
Government services 1.1% 0.8% 0.8% Spending cuts in 2013 and 2014 less severe than in earlier or later years.
Total GDP 0.1% 1.4% 2.4%
Source: ONS for 2012, PwC for 2013 and2014 main scenario projections and key issues.
15UK Economic Outlook November 2013
Figure 2.10: % Output growth by region
Source: ONS
0.0
0.5
1.0
1.5
2.0
2.5
3.0
% g
row
th b
y re
gion
2013 2014
London South East East Anglia South West Yorks &Humber
WestMidlands
EastMidlands
North WestScotland Wales North East N. Ireland UK
Figure 2.11: Alternative UK inflation (CPI) scenarios
Source: ONS, PwC scenarios
Projections
0
1
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% c
hang
e on
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ear e
arlie
r
Main Low inflation High inflation
2010Q1
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2012Q1
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2014Q1
One notable longer term upside risk to inflationrelatestothepriceofclothingand footwear. Until the mid-2000s, thesepriceswerehelddownbycheapproductionbyChinaandotheremergingmarkets.However,risingwagelevels in these emerging markets, combined withincreasedconsumersensitivityto
workingconditions,islikelytoleadtorising input costs in the medium term forclothingandfootwear.Additionally,energypricescouldcontinueontheirstrong upward trend unless there is political intervention to override this. Overall,inflationrisksremainbiased to the upside for the UK.
16 UK Economic Outlook November 2013
Outlook for real earnings growth Theimpactofrelativelyhighinflationhasbeentosqueezerealearningsoverthepastfiveyears,asshowninFigure2.12 below. Over the period from 2008to2012realearningsgrowthhasaveraged-1%perannum.In2013,ourmainscenarioisthatthesqueezeonrealearningswillintensifyfurther,beforemoderatingsomewhatin2014.Butthiswillstillrepresentsixconsecutiveyearsof real earnings declines, which is unprecedented as far back as reliable data goes.
Aswemoveintothesecondhalfofthedecade, we expect real earnings growth toreturntopositiveterritory,butataslowerratethanbeforethefinancialcrisis.Overall,ouranalysissuggeststhatrealearningsby2017willbebackatlevelssimilartothosein2004,butstillaround6%belowpeaklevelsin2008.However,asnotedabove,thisrealearningsrestrainthassupportedhealthyemploymentgrowthinrecentyearsandthisseemslikelytocontinue,sothere is a balance of effects here that needs to be recognised.
2.4 – Monetary and fiscal policy optionsTheBankofEngland’sMonetaryPolicyCommittee(MPC)hasnowkeptmonetarypolicyunchangedforoverayear,withinterestratesat0.5%andthesizeof its asset purchase programme held constant at £375 billion.
TheonemajorinnovationinmonetarypolicysincethetenureofMarkCarneybegan was the new forward guidance that the Bank of England set out in August.ThisstatedthattheofficialBankratewillremainat0.5%andthereremainsthe potential for more quantitative easingmeasuresuntilunemploymentfallsto7%,conditionalonnoneofthefollowing three triggers occurring:
1. IntheMPC’sview,itismorelikelythannotthatCPIinflation18to24months ahead will be 0.5 percentage pointsormoreabovethe2%target;
2. Medium-terminflationexpectationsnolongerremainsufficientlywellanchored; or
3. TheFinancialPolicyCommittee(FPC)judgesthatthestanceofmonetarypolicyposesasignificantthreattofinancialstabilitythatcannotbecontainedbythesubstantial range of mitigating policyactionsavailabletotheFPC,theFinancialConductAuthority and the Prudential Regulation Authorityinawayconsistent withtheirobjectives.
Figure 2.12: Average nominal earnings growth relative to the inflation rate (2001 - 2017)
Source: ONS for 2001-12, PwC analysis (main scenario) for 2013-17
Projections
00.5
1.0
1.5
2.0
2.5
3.0
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5.0
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
% c
hang
e on
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arlie
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CPI Average weekly earnings (excl bonus)
CPI
Earnings
17UK Economic Outlook November 2013
ThisnewpolicymeansthatthequestionofwhentheofficialBankratemightriseisnowintimatelylinkedtothis7%thresholdforunemployment.Box2.1considerwhenthis7%ratemightbereached, concluding that this might be in late 2015 in our main scenario, but notingthatthisissubjecttomanyuncertainties.
FiscalpolicyplanswillbereviewedintheChancellor’sAutumnStatementinDecember, but we would not expect aradicalchangeintheoverallfiscalstance from that set out in the Budget andSpendingReviewearlierthisyear.Publicborrowingislikelytocomeinsomewaybelowtargetthisfinancialyearasgrowthhasexceededexpectations,but we would expect the Chancellor to ‘bank’ all or most of these gains.
2.5 – Summary and conclusionsTheUKeconomygrewbyanestimated0.8%inQ32013accordingtopreliminaryestimates,followingonfrom0.7%growthinthesecondquarter.Therearesignsfromthemostrecentbusinesssurveysthattherecoveryisgainingmomentum,ledbyprivateservicessectors.
WeprojectgrowthfortheUKasawholetobearound1.4%in2013,pickingup toaround2.4%in2014inourmainscenario.ThiscomparestoGDPgrowthofjust0.1%in2012.
Inflationremainedstubbornlyabovetargetat2.7%inSeptemberand,despitesomeprojectedfalltoanaverageof2.4%in2014,wedonotexpectthe2%target rate to be achieved in the near future.Thiswillcontributetowardstherealearningssqueezeofthepast5years
continuingin2014,withpositiverealearnings growth not expected to resume until2015.Thissubduedrealearningsgrowth rate should, however, help to keep employmentgrowthathealthylevels.
Uncertaintystillpervadesalldiscussionsof growth, with risks remaining weighted to the downside in relation to the Eurozoneandpossiblyalsoaslowdowninsomepreviouslystrongemergingmarkets. But there are also upside possibilities for UK domestic demand, notablyasregardsarecoveryinbusinessinvestmentfromnextyearifmajorglobal shocks can be avoided.
Insummary,thereisnowmuchstrongerevidenceofaUKeconomicrecovery, buttherearestilllikelytobesomebumps along the road.
“ There is now much stronger evidence of a UK economic recovery, but there are still likely to be some bumps along the road”
18 UK Economic Outlook November 2013UK Economic Outlook November 201318
Box 2.1 Whenmighttheunemploymentrate fallto7%?
Since the announcement of forward guidancebytheBankofEnglandinAugust,muchattentionhasbeen paid to estimating when the UK unemploymentratemightfallto7%,given that this was the threshold at whichtheMPCsaidthatitwouldstart toconsiderinterestraterises(subject to certain ‘knock-out’ clauses1).
TheBankofEnglandprojectedinitsAugustInflationReportthatunemploy-ment would not fall to this level until late20162, but subsequent movements in short term market interest rates suggest that the market is anticipating a rate rise during 2015. In some cases thiscouldreflectaviewthatoneof the knock-out clauses (e.g. expected inflationabove2.5%)mightcomeintoeffect,butitalsosuggeststhatmanymarketparticipantsmayexpectunemploymenttofallmorequicklybelowthe7%threshold.Sohowlikely issuchanoutcome?
Thetrendintheunemploymentrate willdependontwokeyfactors:
• employmentgrowth,whichwill,in turn,reflectthedifferentialbetweenreal GDP growth and labour product-ivitygrowth(perworker);and
• labour force growth, which will reflectworkingagepopulationgrowth and the percentage of this population that is active in the labourforce(whetheractuallyworkingoractivelylooking for work).
Unemploymentwillfalltotheextentthatemploymentgrowthexceedslabourforce growth. But while working age populationgrowthisrelativelypredictableover the short to medium term, the same is not true of other factors such as productivitygrowthandlabourforceparticipationrates.ThisisshownbytheexperienceofrecentyearswhenGDPgrowth has been sluggish, but labour forceactivityrates,particularlyfor olderworkers,haverisenstrongly.
We can illustrate possible future unemploymentdynamicsanduncertainties with the aid of three scenarios,assetoutinTable2.1.1 and shown in Figure 2.1.1.
Table 2.1.1: Alternative scenarios for the UK unemployment rate
% per annum (average rates from Q4 2013 to Q4 2017)
Lower productivity growth
Main scenario
Higher labour force growth
Real GDP growth 2.4% 2.4% 2.4%
Productivity (output per worker) growth 1.2% 1.6% 1.6%
Employment growth 1.2% 0.8% 0.8%
Labour force growth 0.5% 0.5% 0.6%
Quarter when unemployment first falls to 7% or below
Q4 2014 Q4 2015 Q1 2017
Source: PwC analysis based on initial data from ONS.
1 SpecificallytheMPCmightstarttoraiseinterestratesearlierif:(1)itsexpectationofCPIinflation18-24monthsaheadroseabove2.5%;(2)othermeasuresof inflationaryexpectationswerejudgedtohaveriseninawaythatmightendangerfutureachievementoftheinflationtarget;and/or(3)thattheFinancialPolicy Committeejudgedthismaybeneededtosafeguardfinancialstability.2 TheminutesoftheOctoberMPCmeetingsuggestedthisestimatemightbebroughtforwardintime,butwewillnotgetaprecisenewforecastuntil theNovemberInflationReport.
19UK Economic Outlook November 2013
We can see from Figure 2.1.1 that, in our mainscenario,theunemploymentratemightfalltoaround7%towardstheendof2015,openingthewayforpossibleofficialinterestraterisesbytheMPCfromearly2016(althoughthesewoulddepend on other circumstances at the time).ThisisuptoayearaheadofthebroadtimetableindicatedbytheBankofEngland’sanalysisinitsAugustInflationReport, although that was hedged about with various caveats.
Our alternative scenarios show, however, thatwithlowerproductivitygrowth andsohigheremploymentgrowth,thistimetablecouldeasilybebroughtforwardbyafurtheryear,withunemploymentbelow7%bytheendof2014.Inthesecircumstances,theMPCmightseeanearlyriskofthisfeedingthroughtohigherwage-pushpressuresoninflationand so a stronger case for moving up officialinterestratesfromlate2014orearly2015,aheadevenofthelatestmarket expectations.
On the other hand, our other alternative scenarioshowsthat,withemploymentgrowthheldat0.8%perannumasinourbasecase,evenaverymodestriseinlabour force growth could slow down thefallinunemploymentconsiderably.Inthisscenario,unemploymentmightnotfallbelow7%untilearly2017,ratherlaterthanimpliedbytheBank ofEnglandanalysis.
Inshort,relativelysmallvariationsinourassumptionsonlabourproductivityand labour force growth can have a big impactonwhenUKunemploymentfallsbelow7%,evenmakingnochangetoour baseline GDP growth assumption. If we also varied that assumption, an even broader range of timetables would become possible.
Forward guidance in its current form therefore does not do much to narrow downtherangeofuncertaintyaboutwhentheMPCmightstarttoraiseinterestrates.Thiswillcontinuetodepend on a range of economic factors, muchasinthepreviousinflationtargetingregime.Theonlythingwe cansayforcertainisthatinterestraterises are not on the immediate agenda oftheMPC.
Figure 2.1.1: Alternative UK unemployment rate scenarios
Source: ONS, PwC scenarios
4.0
4.5
5.0
5.5
6.0
6.5
7.0
7.5
8.0
MPC 7% threshold
%
Slower productivity growth Main scenario Higher labour force growth
2013Q4
2013Q2
2014Q4
2014Q2
2015Q4
2015Q2
2016Q4
2016Q2
2017Q4
2017Q2
20 UK Economic Outlook November 2013
3 – How the services sector is rebalancing Britain’s economy1
Key points• TheservicessectorhasbeenleadingtheUKrecovery,whilethemuchhoped-for rebalancing towards manufacturing has not occurred. Buttherehasbeenawidediversityof experience between different activities within the UK services industries. Public administration and financialserviceshavecontractedsignificantlyintermsofoutputandemployment.Meanwhileprofessional,business and support services and thehealthsectorhavegrownstrongly.
• Assuch,therebalancingoftheUKeconomyappearstobetakingplaceprimarilywithintheservicessector.Theprivatesectorisexpandingrelative to the public sector and non-financialservicesaregrowingwhilethecontributionoffinancetooutputandemploymentshrinks.
• Mostsignificantly,servicesgrowthseemstobeincreasinglyfocusedonexports.TheUKisthesecondlargestexporter of services in the world behind the US, and export-oriented service industries account for at least a third of our GDP2.Thepositivetradebalanceonnon-financialservices has doubled as a share of GDPovertherecoveryandtheUKisnow running a services trade surplus of5%ofGDP.Thetradableactivitieswithin the services industries are growingmorestronglythannon-tradables, once allowance is made forthestructuralfallinfinancialservicesoutputandjobs.
• Thereisnoreasonwhythisservices-ledUKrecoverycannotbesustained,as long as the UK remains a competitive and attractive business location and macroeconomicpolicysuccessfullyheads off financial imbalances andcountersinflationarythreats. Adynamicandflexibleservicessectorwhichcancompeteeffectivelyand grow export markets is an asset totheUKeconomy.
IntroductionSince mid-2009, when UK growth resumedafterthefinancialcrisis,services industries have been the main engineofrecovery.Thegrowthofservices output accounts for the entire cumulativeriseinUKGDPof5%in justoverfouryearsofrecoverysofar. Theservicessectorhasalsobeenthemainengineofemploymentgrowth–resulting in the creation of around one millionextrajobsintheUK,despitecutbacks in the public sector.
In one sense this is not surprising. TheservicessectordominatestheUKeconomy,accountingforaroundfour- fifthsofoutputandjobs.Butcomingoutofthefinancialcrisis,seniorUKpolicy-makers appeared to be looking for a rebalancingawayfromtheservicessector,withmanufacturingindustrytakingtheleadintherecovery.
Thathasnothappened–asFigure3.1shows. While the output of the services sectorhasnowpasseditsearly2008peak, manufacturing production is still nearly10%downonitspre-crisislevel.TheshareofmanufacturinginUKnational output has fallen further since thefinancialcrisisandwasjust10.1% ofGDPin2012–comparedwitharound20%in1990andover30%in1970. Bycontrast,asFigure3.2shows,thetotal contribution of services to the value-addedoftheUKeconomyhasrisenfromaround55%in1970to nearly80%in2012.
Figure 3.1: Services are driving the UK recovery
Source: ONS
85
87
89
91
93
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97
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105
2007 2008 2009 2010 2011 2012 2013
Indi
ces
of U
K ou
tput
(200
7 Q1
= 1
00)
GDP Services Manufacturing
Services
GDP
Manufacturing
1 ThisarticlewaswrittenbyAndrewSentance,PwC’sSeniorEconomicAdviser,andBarretKupelian. 2 Althoughnotalloftheoutputoftheseservicesindustriesisexported.
21UK Economic Outlook November 2013
Thefactthattheservicessectorcoverssuchalargepartoftheeconomymeansthat it encompasses a wide range of activities–fromfinancialservicestoretailing, and from hotels and catering tohealthcare.Asaresult,theoveralltrend in the services sector can conceal verybigdifferencesinperformanceacrossindividualcomponents.Thishasindeedbeenthecaserecently,astheanalysisbelowwillshow.
ThediversityoftheUK’sservicessectoralsomeansthatpopularstereotypes can be misleading. For example, the financialservicesindustryisoneofthemore prominent parts of the UK services sector and has attracted a great deal of attentionfollowingthe2008/9crisis.Yetitcurrentlyaccountsforjust10%oftotal UK services output and less than 5%ofjobs.Retailingandwholesaling,transport and communications, business and administrative support services, health, social care and education are the big battalions when it comes to the UK servicessector–togetheraccounting for60%ofservicesoutputandnearlythree-quartersofallservicesectorjobs.
So which are the industries within the services sector that have been driving thecurrentrecovery?Andhowsustainableisaservices-ledrecoveryintheUKlikelytobe?Thisarticleaimstoshed light on these questions. Section 3.1looksatoutputandemploymenttrendsoverthefouryearsoftheUKrecoverysofarandhighlightstheveryvaried experience of different parts of the services sector. Section 3.2 discusses how far these trends suggest that the UK
economyisindeedrebalancing-despitethelackofthesignificantshifttowardsmanufacturingwhichpolicy-makershadhopedfor.Finally,Section3.3considersthesustainabilityofaservices-ledrecoveryintheUKeconomyanditsimplications for economic growth more generallyoverthemediumterm.
Figure 3.2: Long-term shift towards services in the UK
Source: ONS
0
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30
40
50
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90
1970 1980 1990 2000 2007 2012
% s
hare
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oss
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Figure 3.3: Growth in UK services output since 2009
Source: ONS
-15
-10
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% in
crea
se in
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put
Professional,business
and support
Health & Social services
Transport &communications
Wholesale &retail trade
Realestate
Othersevices
Hotels &catering
Education Finance &insurance
Publicadministration,
defence etc
22 UK Economic Outlook November 2013
3 TherearetwodifferentsourcesofemploymentdataintheUK–WorkforceJobs(WfJ)whichisanemployer-basedsurveyandtheLabourForceSurvey(LFS)whichisemployee-based.WfJ–whichalsoincludessecondjobs–showsslightlystrongeremploymentgrowththanLFS:4.3%vs4.0%sinceQ22009.
4 Socialcare,however,whichislargelyfundedfromlocalauthoritybudgets,hasbeenmuchharderhitbypublicspendingcutssince2010.5 ThedatausedinFigure3.4istheWorkforceJobsmeasureofemployment,whichisgenerallyregardedasamorereliableguidetosectoralemploymenttrends bytheOfficeforNationalStatistics.
3.1 – UK services output and employment over the recoveryAftertherecessionprecipitatedbytheglobalfinancialcrisis,therecoveryintheUKeconomybeganinthesecondhalfof2009.Thoughthepaceofrecoveryhas been slow, it now appears to be gatheringpace.GDPhasrisenbyaround5%sincethesecondquarterof2009and,excluding the dampening impact of NorthSeaoil,economicactivityisnowaround6.2%uponitsQ22009trough.Services sector output has risen more rapidlythantheeconomyasawhole,increasingby6.3%sinceQ22009.Strengtheningservicesactivityhas also led the recent acceleration of UK economicgrowthsinceearly2013.
ThefirstpreliminaryestimateofGDPforthethirdquarterof2013hasonlyjustbeenreleased,andafullbreakdownbetween different segments of the services sectorisnotyetavailable.Sointheanalysiswhichfollowswewillfocusonthefirstfouryearsofgrowth–betweenQ22009andQ22013.Overthisperiod,servicessectoroutputroseby5.6% andemploymentrosebyaround4%.3
Figure 3.4: Employment in UK services since 2009
Source: ONS Workforce Jobs Survey
-15
-10
-5
0
5
10
15
20
25
% in
crea
se in
num
bers
em
ploy
ed
Realestate
Professional,business
and support
Health & Social services
Transport &communications
Hotels &catering
Education Othersevices
Wholesale &retail trade
Finance &insurance
Publicadministration,
defence etc
Buttheseaggregatefiguresconcealverysignificantdisparitiesbetweendifferentindustries within the services sector.
Figure 3.3 shows how cumulative growth of output has varied across ten categories within the services sector sincemid-2009.Thedisparityintheperformances of different services industries is striking. Professional, business and support services show the strongest growth, with output up over 20%infouryears–anaveragegrowthrateofnearly5%perannum,three-and-a-half times the average increase for the services sector as a whole over this period.Attheotherendofthespectrumare two parts of the services sector facingabigstructuraladjustment:public administration and related activities;andfinancialservices.Inbothcases,outputhasfallenbynearly10%.However,notallpartsoftheservicessectorwhichdependheavilyonthepublic sector have shown the same trend.Healthandsocialserviceshasrecordedariseinoutputofover10% inthepastfouryears-thesecondstrongestgrowingservicesactivity. Thispictureofstronggrowthdespitethesqueezeonpublicspendingreflects
thegovernment’spolicyofseekingtoprotecttheNationalHealthService4 from the cuts in other areas of departmental expenditure.
In the middle of the pack are a set of services industries which have grown at a rate close to the average for the sector asawhole.Thisincludesactivitieswhich depend on the demand from consumersandbusinesses–retailandwholesale trade, hotels and catering, transport and communication and other services(whicharemainlymiscellaneousconsumer services).
Figure3.4showsacomparable analysisbasedonemploymenttrends.5 Averysimilarpictureemerges–withprofessional, business and support services as well as health and social services showing strong growth. Meanwhile,publicadministrationandfinancialservicesarethetwoareasseeingsignificantfallsinemployment.
23UK Economic Outlook November 2013
Theonlyunusualfeatureoftheemploymentpictureisthestronggrowthinemploymentin“realestate”–property-relatedactivitiesincludingestateagents.Thebulkofthisincreasehastakenplacesinceearly2012and can be linked to other indicators of animprovinghousingmarket–risingmortgage lending, more housing transactions and an upward trend in houseprices.However,itisimportant to set this in context, as the number of employeesengagedintheseproperty-relatedactivitiesisstilljust2%oftotalemployment.Sowhiletheproportionateincreaseislarge,thissectoronlyaccountsforanincreaseof78,000jobssince2009-7%ofservicessectoremploymentgrowthovertherecovery.
AsFigure2.3intheprevioussectionmade clear, other larger sectors with stronger output growth have made a much bigger contribution to the rise in employmentovertherecovery.Indeed,the two parts of the services sector showing the strongest output growth - professional, business and support services and health and social services -accountforaround80%ofthetotalservicesjobsgrowthwehaveseen since the second quarter of 2009.
3.2 – Rebalancing within the services sectorThisanalysisshowsthattherehavebeensignificantshiftstakingplaceintherelative importance of different areas ofactivitywithintheservicessectoroverthecourseoftherecovery.Aswehavealreadyobserved,thisisnottherebalancing towards manufacturing whichpolicy-makershadbeenlookingfor. But in a number of other respects, the changes within the services sector have started to help correct some of the imbalancesintheUKeconomythathaddeveloped during the period of growth beforethefinancialcrisis.
First of all, one of the arguments made forrebalancingtheUKeconomywasthat it had become over-dependent onfinancialservices.Asrecentlyas2000,financialservicesandinsuranceaccountedforlessthan6%oftotalUKvalue-added,butby2009–lessthanadecadelater–thissharehadrisento10.7%.Fallingoutput,employmentandprofitsinthefinancialservicessectorhas seen its share of total UK value addedfallbacktobelow8%in2012. SotheUKeconomyhasrebalancedawayfromfinancialservicestowardsnon-financialactivities–andtheshiftin this direction over the course of the recovery,ofnearly3%ofGDP,has been substantial.
AsecondareaofimbalanceintheUKeconomywhichwasexposedbythefinancialcrisishasbeenthelargedeficitinthepublicfinances,whichreached apeakof11.2%ofGDPin2009/10 andisprojectedtofallto7.5%of GDP (excluding special items6) in thecurrentfinancialyear,2013/14. Thisreductioninpublicborrowinghasbeenpartlyachievedbyasqueeze ondepartmentalandlocalauthoritybudgets,whichisreflectedinthefallintheoutputandemploymentgeneratedbypublicadministrationandrelatedactivities as shown in Figures 3.3 and 3.4above.Thetotalreductioninpublicsectoremploymentovertherecovery–adjustingfortransfersoffurthereducation colleges to the private sector –hasbeenaround500,000,1.7%ofthetotalUKworkforce.Almostallofthesejobreductionswillhavebeenintheservices sector, which means that the private sector has created around 1.5 millionservicesectorjobssince2009,an impressive achievement.
Thethirdareawherethereisevidenceof rebalancing within the services sector is a shift towards overseas demand asakeydriverofgrowth.Beforethefinancialcrisis,UKeconomicgrowthwasheavilydependentondomesticdemand with consumer spending growingparticularlystrongly–increasingby3.7%perannuminthedecade1997-2007,significantlyaboveits historical trend growth rate of 2.5-3%.Reflectingthisstronggrowth of domestic demand, the UK balance of paymentspositiondeteriorated,movingfrom broad balance on the current accountin1997toadeficitofover 3%ofGDPinlate2006.
6 TheitemsexcludedaretherefundofdebtinterestincomewhichtheBankofEnglandreceivesasaresultofitsholdingsofgovernmentbondsandthefinancial impactofthetransferoftheRoyalMailpensionschemetothegovernment.
24 UK Economic Outlook November 2013
AsFigure3.5shows,thedomesticdemanddrivers of growth in the services sector havebeenrelativelyweakoverthisrecoveryperiod.Householdconsumerspendinghasrisenbyjust4%inthefouryearsofgrowthsincethespringof2009–anaverageannualgrowthrateofjust1%(althoughthishaspickedupmorerecently).Governmentconsumption(excluding capital spending) has risen byjust3%inrealterms.Theothermaincomponent of domestic demand, capital spending (not shown on the chart) has actuallyfallenbyover4%duringtherecoveryperiod–thoughthisisnotanimportant driver of services sector growth.
Bycontrast,thevolumeofexportsofserviceshasrisenbyover8%since2009.Thegrowthoftradeingoods–bothimportsandexports–isalsoapotentiallyimportant driver for services sector activity,throughitsimpactonthedemandfor transport, warehousing and other activities linked to the distribution value chain.AsFigure3.5shows,goodstradevolumeshaveincreasedbyover20%inthefouryearsoftherecoverysofar.
TheUKisthesecondbiggestexporterofservices in the world behind the United States and services exports account forover12%ofUKGDP,comparedto anaverageoflessthan6%inFrance,GermanyandItalyandlessthan4%intheUS.Non-financialbusinessservicesarethelargestsinglecategoryofUKexports,makingup30%ofthetotal,andhenceexportgrowthisalikelyexplanation for the strong growth in professional, business and support serviceswehaveseenovertherecoveryto date. Financial services account for justunderaquarteroftotalUKservicesexports with insurance adding a further 8%.Transportandtravelarethetwoother large categories of services exports,makingupnearlyaquarter of the total.
Fromtheearly1970sthroughtotheearly2000s,theUKranatradesurplusonservicesofaround1-2%ofGDP. In the mid-2000s, this services surplus strengthened,risingto4-5%ofGDP,reflectingimprovementsinthetradebalances on all the main exporting sectors–transportandtravel,financeand insurance, and business services. Sincethefinancialcrisis,however,thesurplusonfinancialserviceshasbeendeclining while the trade contribution of other services has been improving.
AsFigure3.6shows,thetradesurplusinnon-financialserviceshasdoubledasashareofGDPsince2008,from1.3%to2.7%.Thedeteriorationinthefinancialservices balance is consistent with the structuraladjustmentinthatindustry,whichisalsoreflectedindecliningfinancialservicesoutputandemployment.But the improvement in trade performance fornon-financialservicessuggeststhatoverseas demand is making a strong contribution to overall services sector growth.
Figure 3.5: Demand drivers for UK services sector
Source: ONS
Figure 3.6: UK trade surplus in services
Source: ONS
95
100
105
110
115
120
125
2009Q2
2009Q3
Key
expe
nditu
re c
ompo
nent
s of
UK
GDP
Consumer spending Government spendingServices exports Trade in goods (imports and exports)
2009Q4
2010Q1
2010Q2
2010Q3
2010Q4
2011Q1
2011Q2
2011Q3
2011Q4
2012Q1
2012Q2
2012Q3
2012Q4
2013Q1
2013Q2
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
Trad
e ba
lanc
e as
a %
of G
DP
2007Q4
Financial services Non-financial services
2008Q4
2009Q4
2010Q4
2011Q4
2012Q4
25UK Economic Outlook November 2013
Ananalysisofthetradableandnon-tradable components of services sector output points to the same conclusion. If export markets are making a noticeable contribution to the growth of the services sector, we would expect that the more tradable activities which are able to drawonstrongerdemandoverseas–like business services, transport and communications,education–wouldbegrowing faster than non-tradables such as retailing, health, hotels and catering. ThatisexactlywhatFigure3.7shows fornon-financialservices.Overthefouryearsofrecoverysofar,tradableservices(excludingfinance)havegrownby11.6% - equivalent to an average annual growth rateof2.8%.Bycontrast,theoutputofnon-tradable services has risen at less than halfthisrate.Ananalysisofemploymenttrends shows a similar picture.
Insummary,therefore,theUKeconomyisrebalancing–butnotinthewayinwhichmanyseniorUKpolicy-makersexpected, or at least hoped for, back in 2009. Instead of manufacturing gaining relative to services, we are seeing significantshiftsinemploymentandoutput within the services industries, alongside an improving trade balance fornon-financialservices.Outputandemploymentinfinancialservicesandsome parts of the public sector are in decline.But,outsidethefinancialsector,tradable services which are able to tap into overseas demand are performing morestronglythannon-tradableactivitiesdependent on domestic demand. Business and professional services seem tobebenefitingparticularlyfromtheabilityofthesesectorstotapintothegrowth of overseas markets.
3.3 – Implications for the sustainability of the UK recoveryHow sustainable is a services-led recovery in the UK economy? One of the arguments against an economytooreliantonservicesisthat it will not be able to generate enough overseasincometopayforrisingimportsastheeconomygrowsandconsumptionincreases.However,as wehaveargued,theUKeconomyhas a track record of export success in servicesthatisnotjustdependenton thefinancialsector.Despitethedeclineinoverseasearningsfromfinance, theUKservicessectoriscurrentlycontributingasurplusofaround5% ofGDPandtheoveralldeficitongoodsand services has narrowed from around 2.5-3%ofGDPbeforethefinancialcrisistoaround1.5%ofGDPinthefirsthalf of2013.ThisisdespitethefactthattheUKtradedeficitongoodsdeterioratedsignificantlysincethelate1990sonwardsandiscurrentlyrunning ataround6-7%ofGDP.
Unfortunately,afall-offininvestmentincomefromabroadlastyearmeantthat,despitethehealthysurplusonservices trade, the UK ran a current accountdeficitof3.8%ofGDPin2012- the fourth highest current account deficittheUKhasrecordedsincetheSecond World War as a share of national output(surpassedonlyin1974after thefirstOPECoilpriceshockandatthepeakoftheLawsonBoomin1988/9).However,theUK’sbalanceoftrade in goods should improve as the euro areaeconomiesgraduallyrecoveroverthenextfewyears,helpingtoprovidestronger demand for manufacturing exportsandnarrowthedeficitongoodstrade. Investment income from overseas should also recover as it starts to reflectthebroaderrecoveryinthe globaleconomy.
Figure 3.7: Output of non-financial services
Source: PwC calculations based on ONS data
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Wei
ghte
d in
dice
s of
ser
vice
s ou
tput
2009Q2
Tradable activities Non-Tradables
2010Q1
2009Q3
2010Q2
2009Q4
2010Q3
2010Q4
2011Q3
2011Q1
2011Q4
2011Q2
2012Q1
2012Q2
2013Q1
2012Q3
2013Q2
2012Q4
26 UK Economic Outlook November 2013
Thereisalsothepotentialforfurthergrowth in the export of services. Some of the biggest contributors to UK overseas earnings in the services industries-businessandfinancialservices, travel and tourism, education and the creative industries (including design and media) - together account directlyforaroundathirdofUKGrossValueAdded7.Thisismorethanthreetimes the contribution to national outputfrommanufacturingindustryand highlights the potential for the UK to take advantage of expanding trading opportunitiesinservices.Theprospectof further liberalisation of services trade withintheEuropeanUnionandglobally(notablywiththeUS)shouldhelptheUK to realise more of its export potential in the services industries.
Anotherconcernaboutservicesector-led growth is that it could be associated withlowproductivitygrowth.Since1997,outputperhourhasincreasedby1.4%per annum on average in UK services, as comparedwith2.9%inmanufacturing.However,themoretradableareas ofservices–includingbusinessandfinancialservices-havetendedtoachievehighproductivitylevelsandfaster growth rates. Just as in manu-facturing in the past three decades, the UKwillachievehigherproductivitylevelsandstrongerproductivitygrowthif we succeed in developing higher value-added activities and attracting themtooureconomy.
It is possible to envisage scenarios in which service sector-led growth leads tonewimbalancesintheUKeconomy.Forexample,ifthecurrentrecovery in the housing market develops into a broader housing market bubble, perhaps exacerbatedbythegovernment’sHelp toBuyscheme.Ordomesticdemandcouldbeallowedtoincreasetoorapidly,fuellinga1980s-styleinflationaryboom. So to be sustainable, a services-led recoveryneedstobeaccompaniedbysound macroeconomic management, andthatislikelytorequiresomenormalisationofmonetarypolicyin theyearsahead,includingagradual rise in interest rates later this decade (as discussed in Section 2 above).
Conclusion We should not see the dependence of the UK’seconomicrecoveryonthegrowthof services output as a source of economic weakness.TheUKeconomymaynotberebalancing towards manufacturing, but there is a range of evidence that the successful industries within the services sector are tapping into the growth of overseas demand. Rebalancing is therefore taking place within the services sector, rather than between manufacturingandservices.Aslongasthe UK remains an attractive location forinternationalbusinessactivityandinvestment,andoureconomyisrunonsoundfiscalandmonetaryprinciples,thereisnoreasonwhythecurrentservices-ledrecoveryshouldnotcontinueandgathermomentum–asindeedourlatesteconomicprojectionssuggestshouldhappenoverthenextfewyears.
“ The UK economy may not be rebalancing towards manufacturing, but there is a range of evidence that the successful industries within the services sector are tapping into the growth of overseas demand”
7 In2012,professionalandbusinesssupportservicesaccountedfor12%ofUKGVA,financeandinsurance7.9%andeducation6.4%.RecentstudiescommissionedbytheUKgovernmentputthedirectcontributionoftravelandtourismtotheUKeconomyat4%ofGDP(9%includingindirectimpacts)withcreativeindustriesadding2.9%.
27UK Economic Outlook November 2013
4 – Consumer spending trends to 20301
Key points• Totalconsumerspendingcouldgrowbyaround2%perannuminrealterms on average to 2030, but this couldvaryfromaroundzerorealgrowth for food, clothing and alcohol&tobaccotoaround2.5-3%for housing and utilities, health and recreation and culture.
• Housingandutilitiesnowaccount for around a quarter of total household spending,upfromjustover20%beforethefinancialcrisis.Thiscouldrisetoaround30%by2030asrealutilitypricescontinuetoincreaseand the housing market picks up.
• Spendingonfinancialservices,overseasholidaysandotherdiscretionaryspendinghasbeensqueezedsincethecrisis,butshouldshowsomerecoveryinthelongertermastheeconomypicksup.
• Consumers will, however, remain more price-conscious as on-line retailers and high street discount stores continue to take an increasing share of the market even after the economyrecovers.
1 ThisarticlewaswrittenbyBarretKupelianandJohnHawksworth.
Table 4.1: Historic trends in budget shares for major spending category (% of total spending)
Spending category Budget share
in 1963 (%)
Budget share
in 2007 (%)
Budget share
in 2012 (%)
Change since 1963
(pps)
Change since 2007
(pps)
Alcohol and tobacco 8.4 3.5 3.6 -4.8 +0.1
Clothing 10.5 5.5 5.9 -4.6 +0.3
Communications 0.9 2.2 2.1 +1.2 -0.1
Education 0.5 1.4 1.5 +1.0 +0.1
Food 24.1 8.5 9.2 -14.9 +0.7
Furnishing 7.6 5.5 5.0 -2.7 -0.6
Health 1.0 1.7 1.6 +0.6 -0.1
Housing and utilities 13.5 21.0 26.0 +12.5 +4.9
Miscellaneous services 6.4 14.2 10.5 +4.1 -3.7
Recreation and culture 7.8 11.7 10.6 +2.8 -1.2
Restaurant 9.8 10.1 9.9 +0.1 -0.2
Transport 9.7 14.6 14.4 +4.7 -0.2
Total 100 100 100 0 0
Source: PwC analysis of ONS data
IntroductionTotal consumer spending accounts for over 60% of UK GDP and is therefore critical from a macroeconomic perspective.From a business perspective however, italsomattersgreatlywhatproportionof total spending is allocated to particular categories like food, clothing, housing and utilities, transport and education.
Over a longer period of time, the mix of spending changes as consumer preferences, the relative prices of different goods and services, real incomes, technologyandotherfactors(e.g.inequality,taxes)evolveovertime.Businesses need to take these factors into account in their long term strategies.
Section 2 above looked at the short term outlook for consumer spending. In this article we provide a longer term perspective of past and future prospects. Thediscussionisorganisedasfollows:
• Section4.1describesanddiscusseshistorical trends in consumer spendingpatterns,particularlyintheperiodsincethefinancialcrisis;
• Section4.2usesourexistinghousehold consumer spending modeltoprojectconsumerspendingpatterns to 2030;
• Section4.3looksatalternativescenarios for how consumer patterns mayevolvebetweennowand2030;
• Section4.4drawsoutpossibleimplications for business; and
• Section4.5summarises and concludes.
28 UK Economic Outlook November 2013
4.1 – Historical consumer spending trendsLong term trends (1963-2012)TheNationalAccountsdivideconsumerspending into 12 broad categories. Figure4.1showshowspendingacrossthe main categories (referred to below as ‘budget shares’) has varied since 1963,whichisthefirstyearforwhichcomparable data is available from the OfficeforNationalStatistics(ONS).
Table4.1setsoutthisinformationinmore detail and compares how the spending mix has changed over time.
Themostnotablechangessince1963are that:
• Basic goods such as food, alcohol, clothing and furnishing saw a marked decline in their budget share. Mostdramatically,fooddeclinedfrom24%oftotalspendingin1963tolessthan10%in2012.
• In contrast, the largest rises were recorded in the housing and utilities, transport and miscellaneous spending2 categories.Mostimportantly,2011markedthefirstyearwhenthespending share on housing and utilitiesbrokethe25%barrier.
• Spending in other categories like recreation and culture, communication, education and health3 have not changedmateriallyasaproportionof total spending.
Havethelongtermchangesinthebudget shares described above been reflectedinthetrendsobservedin theperiodsincethefinancialcrisis? Toanswerthisquestion,wehaveanalysedconsumerspendingtrendssince 2007 in more detail.
Trends since the financial crisis (2007-2012)Thisperiodisnotablefortworeasons.First, it covers a period where the UK economyexperienceditssharpestpost-war recession. Second, it is a period inwhichhouseholdfinanceshavecomeundersignificantpressurewithpriceinflationratesoutstrippingwagegrowth(as discussed in Section 2 above) with an associated average decrease in real consumptionof0.6%perannumsince2007.Soouranalysisoffersaguidetohow households have behaved in a period of considerable stress.
Table4.1showsthat:
• Theshareofspendingonhousingandutilitiesrosefrom21%in2007to26%in2012.Thisreflectssharprisesinrealrentlevelsandutilitybills,whichhassqueezedspendinginothermorediscretionaryareas.
• Themainimpactofthishasbeenreduced spending in the miscellaneous, recreation and culture and, furnishing categories.Around50%ofthespending in the miscellaneous categoryismadeupoffinancial and insurance services, which took a particular hit in the crisis as households reduced their debt position (e.g. on credit cards and other forms of unsecured loans).
• Theshareofspendingonfoodincreasedmarginallyfrom8.5%in2007to9.2%in2012.Althoughthisis a small change, it is worth noting that2008wasthefirsttimesince1973 when the share of household spending on food has increased. Thisreflectsrisingpricesoffood inthatyear.
Figure 4.1: Historical trends in budget shares for major spending categories (% of total spending)
Source: PwC analysis of ONS data
0
5
10
15
20
25
30
Housing & utilities
1963 1967 1971 1975 1979 1983 1987 1991 1995 1999 2003 2007 2011
% o
f tot
al h
ouse
hold
spe
ndin
g
FurnishingsAlcohol & tobacco
RestaurantHousing & utilitiesClothing
TransportMiscellaneous servicesEducation
Recreation & cultureFood
2 Miscellaneousspendingincludesfinancialservicesandpersonalcaregoodsandservicesnotincludedinothercategories.3 Notethatspendingoneducationandhealthhererefersonlytoprivatespendingbyhouseholds.
29UK Economic Outlook November 2013
Themainthemecomingoutfromtheaboveanalysisisthat,giventhesqueezeonavailablespendingmoneysince 2007, households have re-allocated their spendingawayfromnon-essentialitemslike recreation and culture, furnishing and other miscellaneous items towards essential items like housing, utilities and food.
Inanalysingchangesinbudget,itisuseful to distinguish between the effect of relative price changes and the effect of growth in the volume of goods and services consumed, as shown inFigure4.2.
Figure4.2showsthat:
• Therehasbeenastrongdownwardtrend in the relative prices of clothing (cheap imports from the Far East and other low cost producers still seem to be a factor here), recreation and culture (cheaper books and magazines)andthemiscellaneousspendingcategory(recordlowinterest rates and household deleveraging).
• Therelativepriceofeducationhasrisenverystrongly(morethan4%per annum) in large part due to the sharpriseinuniversityfeesfordomestic students and also because of the continued robust demand forhigh-qualityeducationfrominternational students who are willingtopayapremiumfor both private schools and leading universities.
• Thepriceofhousingandutilitieshasincreasedataround3%perannumdue to a mixture of rising rent levels andhigherutilitybills(electricity,gas and water).
• Alcoholandtobaccoaswellasfoodprices have also increased because of highcommoditypricesoninternationalmarkets (although this effect is graduallycomingtoanend)and,inpart, due to continued increases in excise duties on alcohol and tobacco.
• Therelativepriceoftransporthasrisen owing to a combination of higher petrol prices and above inflationincreasesintrainfares.
Turningtovolumegrowth,Figure4.2shows that:
• Poor economic conditions coupled with the price rises mentioned, has led to some decrease in the demand for (paid for) education. On the other hand, the decrease in demand for formaltertiaryeducationmaygosomewaytoexplaintheresurgencein demand for apprenticeships and other forms of vocational training.
• Volume growth for the miscellaneous categoryisdown,ledbyacontractionofdemandforfinancialservices.Thispatternisinlinewiththebroader macroeconomic picture in whichhouseholdshavebeenpayingdowntheirdebts,therebyreducingdemandforfinancialproducts.
• Volume growth for housing and utilitiesincreasedbyaround0.8%perannum.Thisisdespiteanaveragepriceincreaseofaround3%per annum mentioned above, reflectingthelimitsonhowfarconsumption of these essential items can be reduced.
Figure 4.2: Relative price and volume growth by spending category since 2007
Source: ONS, PwC analysis
-8
-6
-4
-2
0
2
4
6
8
% p
er a
nnum
ave
rage
cha
nge
(200
7-12
)
Volume growth Relative price change
Alcoholand tobacco
Clothing Communication Education FurnishingFood Health Housing andutilities
Miscellaneousservices
Receationand culture
Restaurant Transport
30 UK Economic Outlook November 2013
• Themostrapidvolumegrowthwasseeninspendingonclothing(6.6%increase per annum) and recreation andculture(1.5%perannum),bothof which saw a decline in relative price levels.
• Thesharpestcontractionsinvolumegrowth (excluding the categories mentioned above) were seen in alcohol and tobacco, furnishing, transport, restaurant and food. Allbutoneofthesecategories(furnishing) saw a relative price increase, which helps to explain reduced volume demand together withthesqueezefromrisingrentandutilitybills.
Box4.1providesamoredetailedbreakdown of which areas of household spending have grown or contracted mostmarkedlysince2007.
4.2 – Baseline projection for consumer spending patterns to 2030IntheMarch2011editionofUKEconomicOutlook4, we presented a household consumer spending model and used this toprojectpatternsto2030.Thekeyinputs to this model, which was based oneconometricanalysisofdatasince1963,were:
• Real income levels(proxiedbyrealconsumer expenditure);
• Relative price levels, which in turn weredrivenbyworldoilprices,exchange rates and tax (indirect, exciseduty)changesandatimetrend; and
• Other socioeconomic factors such as income distribution and the age structure of the population.
Weusedourmodeltoprojectconsumerspending patterns to 2030 based on the latestavailableactualdata.Inprojectingrelative price levels we made some additionaljudgementalassumptionswhere we considered that there have beensignificantstructuralchanges,which meant that the past was not an entirelyreliableguidetothefuture. In particular, we assumed that:
• Real housing and utility prices will notincreaseasquicklyinthefutureas their historical average rate (1.6%comparedto2.3%perannumtrend rate), which was due to some exceptionalfactorsthatseemunlikelyto continue to the same degree (e.g.sharpenergypricerisessincethe late 1990s).
• Real food prices are assumed to riseby1.5%perannum,reflectingincreased demand from emerging economies; this is a reversal of the real food prices falls seen in previous decades, but is more representative ofrecentandlikelyfuturetrends in our view.
Figure 4.3: Baseline projections for household budget shares in 2020 and 2030
Source: ONS for 2012, PwC baseline model projections for 2020 and 2030.
0
5
10
15
20
25
30
35
% o
f tot
al h
ouse
hold
spe
ndin
g
Alcoholand tobacco
Clothing Communication Education FurnishingFood Health Housing andutilities
Miscellaneousservices
Receationand culture
Restaurant Transport
2012 2020 2030
4 “HowmightUKconsumerspendingpatternschangeoverthenext20years?”UKEconomicOutlook,March2011.
31UK Economic Outlook November 2013
• Real transport costs are assumed to riseatatrendrateofaround1%perannumtoreflectpotentialhigherprices associated with environmental factors (e.g. carbon taxes and other energytaxes)andapotentialextension of congestion pricing.
Thesejudgementaladjustmentsareopen to debate, but give more plausible long-termprojectionsfortheaffectedcategories than using a model derived purelyfromhistoricaldata.Itshouldbealso noted that we are focusing here on long term trends rather than short termcyclicalvariationsandothertemporaryfluctuationsinhouseholdbudget shares.
Baseline projections Figure4.3showsourbaselinemodelprojectionsusingthefollowingadditional assumptions:
• Totalrealconsumptionexpendituregrowsatanaveragerateof2.1%perannum, which is in line with the latestofficialestimatesoftheOfficeforBudgetResponsibility(OBR).
• Incomeinequalityremainsatthelatest estimated levels.
• Therelativesizeofdifferentagegroups evolves as in the latest ONS projections,implyingasteadyriseinthe proportion of people above the ageof65.
Figure4.3showsthatthesharesofspending on food, alcohol and tobacco, andclothingareprojectedtocontinue todeclinesteadilyasinpastdecades. Itmaybemoresurprisingthatthisalsoapplies to the share of spending on transport, although in fact this has alreadybeenonadecliningtrend sincethelate1980sasshownin Figure4.1above.
Thesedownwardtrendsareoffsetbyrising shares of spending on housing and utilities, recreation and culture and, miscellaneous services in particular. Againthisrepresentsacontinuation of long-term historic trends, although a reversal of recent ones in the case ofmiscellaneousspending(financialservices etc.) and recreation and culture,whichhavebeensqueezedduring the recession but are expected torecoverastheeconomyrevives infutureyears.Privatehealthspending isalsoboostedbyrealincomegrowthand an ageing population.
4.3 Alternative scenarios We have developed two alternative scenarios to explore some of the uncertaintiesthatinevitablysurroundanysuchlongtermprojections.
Thefirst‘optimistic scenario’ assumes:
• Stronger total real household expendituregrowth(3%perannum).
• Decliningrealworldoilprices(by2%perannumto$69perbarrelin2030attoday’sdollarvalues).
• Lowerindirecttaxes(VATdownto15%by2030duetostrongergrowthboosting other tax revenues).
Thesecond‘pessimistic scenario’ assumes:
• Weaker total real household expend-ituregrowth(1%perannum).
• Risingrealoilprices(by2%perannumto$141perbarrelin2030 attoday’sdollarvalues).
• Higherindirecttaxes(VATupto25%by2030tomakeupforslowergrowth in other tax revenues).
TheresultsaresummarisedinTable4.2intermsoftheprojectedbudgetsharesin 2030 in these alternative scenarios relativetoourbaselineprojections.Averageannualrealspendinggrowthrates in the period to 2030 in different scenariosarethenshowninTable4.3.
32 UK Economic Outlook November 2013
Table 4.2: Household budget share projections for 2030 in alternative scenarios
Spending category 2012 spending share
2030 baseline
projection
2030 optimistic scenario
2030 pessimistic
scenario
Alcohol and tobacco 3.6% 2.6% 2.1% 2.5%
Clothing 5.9% 3.9% 3.8% 3.9%
Communications 2.1% 2.1% 2.1% 2.0%
Education 1.5% 1.5% 1.4% 1.4%
Food 9.2% 6.4% 5.4% 6.3%
Furnishing 5.0% 5.3% 5.8% 5.2%
Health 1.6% 1.7% 1.7% 1.7%
Housing and utilities 26.0% 30.0% 28.5% 29.8%
Miscellaneous services 10.5% 12.2% 13.0% 12.5%
Recreation and culture 10.6% 11.2% 11.8% 11.1%
Restaurant 9.9% 10.0% 10.4% 9.9%
Transport 14.4% 13.2% 14.0% 13.5%
Total spending 100% 100% 100% 100%
Source: ONS for 2012, PwC model scenarios for 2030
Table 4.3: Average annual real growth rates by household spending category in alternative scenarios (% pa: 2013-30)
Category Baseline projection Optimistic scenario Pessimistic scenario
Alcohol and tobacco 0.2% 0.0% -1.0%
Clothing -0.2% 0.6% -1.2%
Communications 2.0% 3.1% 0.8%
Education 2.0% 2.7% 0.8%
Food 0.1% 0.0% -1.0%
Furnishing 2.4% 3.8% 1.3%
Health 2.5% 3.3% 1.3%
Housing and utilities 2.9% 3.5% 1.7%
Miscellaneous services 3.0% 4.2% 2.0%
Recreation and culture 2.4% 3.6% 1.3%
Restaurant 2.2% 3.3% 1.0%
Transport 1.6% 2.9% 0.7%
Overall 2.1% 3.0% 1.0%
Source: ONS for 2012, PwC model scenarios for 2013-2030 average growth rates
TheresultsinTables4.2and4.3showthattherecouldbesignificantvariationsin spending shares and growth rates depending on the macroeconomic assumptions adopted, although effects varybycategory.Thosespendingcategories that are less responsive to changes in income, such as food, alcohol and tobacco, and housing and utilities, haveprojectedrealgrowthratesthattendtovarylessacrossdifferentscenarios.Theoppositeistrueforcategoriessuchas transport, recreation and culture, and restaurants where demand is more sensitive to income changes.
On the other hand, some broad trends remain robust across all scenarios e.g. the shift in spending from food, alcohol and tobacco towards housing and utilities,aswellashealth(partlydrivenbyagreaternumberofpeopleinthe65+agebracket).
4.4 – Implications for business5
Asdiscussedabove,challengingeconomic conditions have changed consumer spending patterns and habits. Themostnotablechangeisthathouseholds are now spending a greater proportion of their budget share on essentials like food and household goods.Asaresult,consumershavebecome more sensitive to the prices of essential items and are focused on reducing wasteful spending.6 In contrast to the pre-crisis decades, a cultural threshold seems to have been crossed - a consumer who looks out for low cost dealsandreduceswaste(particularlybutnotonlyforessentialitems)isnowconsidered ‘smart’.
5 WeareverygratefultoLisaHooker,DavidOliverandMatthewTodfortheirhelpfulinsightsonchangingtrendsintheretailandconsumersector, which we draw upon in this part of the article.
6 Asrecognised,forexample,byTescoinitsrecentreport‘Usingourscaleforgood’(2013/14halfyearupdate).
33UK Economic Outlook November 2013
The emergence of the ‘smart’ consumer has affected how businesses compete in the marketplace. For example:
• Harddiscounters(e.g.Aldi,Lidletc.)haveflourishedonthebackofdemand for their low-cost but reasonablequalityproducts;forthefirsttime,someofthese‘discounters’have increased their market share above10%;
• Highstreetdiscounters(e.g.Poundland,99pstoresandHomeBargains) have increased their presenceinsecondarylocations(areas close to the high street that havehighfootfall).Theyhavebeenparticularlysuccessfulinrespondingto demand for high-volume, low- costproductssuchaseverydayconsumables (shampoos, detergent, cleaning materials etc.);
• Specialisedcharityshopshaveflourishedonthehighstreetandarenowconsideredasagoodwayofgetting a bargain on a wide range of second hand goods (ranging from clothes to books);
• Thelargerout-of-townsupermarketshaverespondedtothesetrendsbyexpanding the breadth of their in-house low cost products.
During the same period, we have also seen a gradual increase in the role of the internet in retail transactions (including online trading sites such aseBay).Thelatestofficialdatafrom the ONS shows that:
• Internet transactions now make up around10%oftotalretailsales, upfromjust3%in2007.
• One in ten pounds that is spent on clothing and footwear is now through online sales, compared toaround6%in2010;
• Some other sectors, however, still havealongwaytogoe.g.onlyaround3%offoodsalesarethroughonline channels (fast and reliable homedeliveryremainsapotentialbarrier here, although some customersmaybehappytoorderonlineandpickuptheirgrocerypurchases in store later).
Thisgradualshiftindemandfromtraditional high street to digital channels has had a number of important implications for businesses:
• Revenue:Ashifttodigitalhasnotnecessarilytranslatedtoextrademandvia higher revenues, but businesses have been able to protect their revenue (rather than losing out to online competitors)bysettingupmulti-channel distribution networks;
• Expenses have, however, increased as the shift from a ‘single-channel’ to a ‘multi-channel’ distribution framework has meant more spending on setting up and maintaining an e-commerce infrastructure; this createstheneedforastrategythatbetter integrates digital and traditional channels into a single framework; and
• Competitionhasintensifiedasithasbecome easier to compare prices for similar products. In the medium term, this could lead to some downward pressureonprices(andconsequentlyprofitmargins)ascomparisonwebsites become more popular across an ever wider set of products.
• Strategy: Retailers have to be much clearer on their proposition and targeting.Thesuccessthathighstreet discounters have experienced, evenfiveyearsafterthefinancialcrisis,highlightsthebenefitsofimplementingatransparentstrategy.
34 UK Economic Outlook November 2013
7 ThislatterpointisdiscussedfurtheronourTotalRetailwebsite.http://www.pwc.co.uk/retail-consumer/total-retail/move-from-multi-channel.jhtml
The emergence of ‘smart’ consumers along with the simultaneous shift to online sales means that businesses are under increased scrutiny, both on pricing and on wider issues such as environmental impact and working conditions in overseas suppliers.
Businesses need to take long term trends into account when planning ahead.Thekeyquestionsforcompaniesoperating in retail and consumer markets would include:
• Howwelldoyouunderstandthesensitivityofdemandinyourmarketsto relative price, income movements andinternetpenetration?
• Howmightfactorssuchasanageingpopulation affect demand patterns inyourmarketsinthefuture?
• Doyouhavemodelsthatallowyouto capture these effects in a rigorous wayandprojectforwarddemand in alternative macroeconomic scenarios?
• Doyouhavenotjustadigitalstrategy,butabusinessstrategy forthedigitalage?7
4.5 Summary and conclusionsTheperiodsince2007hasbeenastressfultime for UK households with negative real consumer spending growth and pricepressuresmounting.Householdshave had to make tough choices as:
• housing and utilities have taken up an ever greater proportion of total budgets; and
• food prices have risen, which is a reversal of historical trends.
Asgrowthresumesandconsumptionstartstopickupoverthenextfewyears,we expect that:
• Totalconsumerspendingmightgrowbyaround2%perannuminrealterms on average to 2030, but this couldvaryfromaroundzerorealgrowth for food, clothing and alcohol &tobaccotoaround2.5-3%forhousing and utilities, health, and recreation and culture.
• Housingandutilitiesnowaccount for around a quarter of total spending, upfromjustover20%beforethefinancialcrisis,andthiscouldrisetoaround30%by2030asrealutilityprices continue to increase and the housing market picks up.
• Spendingonfinancialservices,overseasholidaysandotherdiscretionaryspendinghasbeensqueezedsincethecrisis,butshouldshowsomerecoveryinthelongertermastheeconomypicksup.
• Consumers will, however, remain more price-conscious as on-line retailers and discount stores continue to take an increasing share of the market evenaftertheeconomyrecovers.
“ Housing and utilities spending share could rise to around 30% by 2030 as real utility prices continue to increase and the housing market picks up ”
Box 4.1 TopandBottom10moversinhouseholdspending shares since 2007
The analysis in the main text focuses on the trends across the 12 spending categories specified by the ONS. However, this might hide big swings within these categories.
Toaddressthisissue,wehavelookedatthe top and bottom 10 changes in the sub-categories that make up the 12 categories. We have used data from the ONS covering the 2007-2012 period. We have also taken into account the spending patterns of UK consumers abroadandofvisitorstotheUK.Table4.4showsthetop10andbottom10changesinbudgetsharesbyspendingsub-categories since 2007.
Table4.4showsthat:
• Food, rent, utilities and clothing are themainupwardmovers.ThisisinlinewiththebroadtrendsidentifiedinourdiscussioninSection4.1.
• Therisingbudgetshareofthepersonaleffectssub-categoryisincontrasttothe3.7ppdecreaseobservedinTable4.2fortheoverallmiscellaneouscategoryintowhichitfalls.Someofthe items included under ‘personal effects’relatestoprams,cots,babycarseatsandbabycarriers.Therisein the UK birth rate since the turn ofthecenturymayhelptoexplainthis upward trend.
• Thedramaticdeclineinthebudgetshareofthefinancialandinsuranceservicessub-sectorgoesalongwayto explain the decrease in the miscellaneous budget share identifiedinTable4.2.
• Thespendingshareforaudio-visual,photo and information processing partlyexplainsthereductionintherecreation and culture budget share of1.2ppssince2007.However,thistrend has more to do with consumers benefittingfromcheaperelectronicsfrom the Far East (the relative price of recreation and culture has decreasedby4%perannumsince2007) than with lower volumes of consumption.Also,complementarygoods(e.g.Netflix,Lovefilm)haveenhanced the capabilities of existing audio-visual equipment.
• Thebudgetshareofnewspapers,booksandstationaryhasdecreased.Thishastodowiththedownwardprice pressure that online retailers have exerted and also because of the rise of e-readers that have made the distribution of products like e-books ande-magazinespossible.
Table 4.4: Top 10 increases and decreases in budget shares by spending sub-category (2007-12)
Spending sub-category Increasing shares (pps)
Spending sub-category Decreasing shares (pps)
Rent +4.5 Financial services -2.7
Food +0.7 Insurance -0.8
Electricity, gas and other fuel +0.5 Tourism spending abroad -0.7
Clothing +0.3 Audio-visual, photo and information processing
-0.6
Personal effects +0.2 Newspapers, books and stationery
-0.4
Operation of personal transport equipment
+0.2 Furniture and flooring -0.3
Recreational and cultural services
+0.1 Vehicle purchases -0.3
Accommodation services +0.1 Other recreational goods -0.3
Tobacco +0.1 Catering services -0.3
Water supply and miscellaneous services
+0.1 Social protection -0.1
Source: PwC analysis of ONS data (pps = percentage points of total spending)
35UK Economic Outlook November 2013
• Finally,spendingbyBritishtouristsabroad has also declined, making up a smaller proportion of total household spending.Thismakessenselookingatthebroadertrendsintheindustry,which show that UK visits abroad havedeclinedto56millionin2012from almost 70 million in 2007. Thismayinpartbeduetoaweakerpound,whichlostover20%ofitsvalue in the same period.
36 UK Economic Outlook November 2013
Appendix A Outlookfortheglobaleconomy
TableA.1presentsourlatestmainscenarioprojectionsforaselectionofeconomiesacrosstheworld.TheEurozoneas a whole still shows negative growth on average in 2013, but with the outlook improvingin2014,ledbyGermany. USgrowthshouldalsopickupnextyear.World economic growth will continue tobeledbytheemergingeconomiesalthoughmanyofthesehaveslowed downrecently.TheseprojectionsarenowupdatedmonthlyinourGlobalEconomyWatch publication, which can be found at http://www.pwc.co.uk/economic-services/global-economy-watch/gew-projections.jhtml.
Table A.1: Global economic prospects
GDP-weighted averages Share of World GDP
GDP growth (%)
Consumer price inflation (%)
(2012 at MERs) 2013p 2014p 2013p 2014p
World (PPP weights) 2.8 3.5
World (market rates) 100.0% 2.2 3.0 4.6 5.1
Eurozone (market rates) 18.8% -0.5 0.9 1.4 1.6
Country
United States 21.7% 1.6 2.7 1.4 1.8
Canada 2.5% 1.5 2.2 1.0 1.5
Germany 5.1% 0.5 1.5 1.6 1.8
France 4.0% 0.1 0.8 1.1 1.6
United Kingdom 3.5% 1.4 2.4 2.7 2.4
Italy 3.2% -1.8 0.3 1.2 1.5
Spain 2.1% -1.1 0.7 1.6 1.2
Netherlands 1.2% -1.3 0.4 2.9 2.2
Greece 0.4% -3.8 0.2 -0.3 0.0
Ireland 0.3% 0.2 2.4 0.8 1.3
Portugal 0.3% -1.7 1.0 0.8 1.2
China 10.5% 7.6 7.5 2.8 3.0
Japan 8.4% 1.8 1.7 0.3 1.6
India 2.4% 4.5 5.5 6.5 7.5
Australia 2.1% 2.5 2.7 2.1 2.5
South Korea 1.6% 2.6 3.2 1.7 2.5
Indonesia 1.2% 5.6 5.8 7.3 6.5
Saudi Arabia 0.8% 4.4 4.2 4.0 4.6
Russia 2.7% 1.9 3.1 6.6 5.9
Turkey 1.1% 3.6 3.8 7.4 6.4
Poland 0.7% 1.1 2.3 1.3 2.2
Brazil 3.6% 2.2 2.7 6.1 5.5
Mexico 1.7% 1.9 2.9 3.8 3.8
Argentina 0.6% 2.9 2.5 10.6 11.3
South Africa 0.6% 2.1 3.5 5.7 5.7
Source: Latest PwC main scenario for 2013-14; IMF for GDP shares in 2012 at market exchange rates (MERs).
37UK Economic Outlook November 2013
Appendix B UKeconomictrends:1979–2012
Annual averages GDP growth Household expenditure growth
Manufacturing output growth
Inflation (CPI*)
3 Month interest rate (% annual average)
Current account balance (% of GDP)
PSNB** (% of GDP)
1979 2.8 5.0 -0.2 13.7 -0.5 4.7
1980 -2.0 0.1 -8.6 16.6 0.8 4.3
1981 -1.3 0.0 -6.1 13.9 1.9 3.4
1982 2.2 1.2 -0.1 12.2 0.8 2.6
1983 3.8 4.6 2.1 10.1 0.4 3.4
1984 2.9 2.8 3.7 10.0 -0.4 3.7
1985 3.9 4.3 2.9 12.2 -0.2 2.8
1986 4.3 7.1 1.4 10.9 -0.9 2.2
1987 5.2 6.2 4.8 9.7 -1.6 1.5
1988 5.6 8.4 7.3 10.4 -3.9 -0.8
1989 2.6 3.9 4 5.2 13.9 -4.6 -0.8
1990 1.8 2.4 -0.1 7.0 14.8 -3.5 0.7
1991 -1.3 -2.2 -4.9 7.4 11.5 -1.4 3
1992 1.3 1.6 -0.1 4.3 9.6 -1.7 6.5
1993 3.5 4.1 1.4 2.5 5.9 -1.4 7.8
1994 5.0 3.4 4.9 2.1 5.5 -0.5 6.6
1995 3.5 2.1 1.5 2.6 6.7 -0.7 5.3
1996 3.5 5.0 1.2 2.4 6.0 -0.6 3.7
1997 4.4 4.9 1.9 1.8 6.8 -0.1 1.9
1998 3.6 4.1 0.6 1.6 7.3 -0.4 -0.1
1999 2.9 5.2 0.5 1.3 5.4 -2.7 -1.3
2000 4.4 5.5 2.2 0.9 6.1 -2.9 -1.7
2001 2.2 3.8 -1.7 1.2 5.0 -2.3 -0.8
2002 2.3 4.0 -2.4 1.3 4.0 -2.1 1.8
2003 3.9 3.8 -0.5 1.4 3.7 -1.7 3
2004 3.2 3.2 1.9 1.3 4.6 -2 3.2
2005 3.2 2.9 -0.2 2.0 4.7 -1.8 3.4
2006 2.8 1.8 1.8 2.3 4.8 -2.8 2.5
2007 3.4 2.8 0.8 2.3 6.0 -2.2 2.6
2008 -0.8 -0.9 -2.7 3.6 5.5 -0.9 4.8
2009 -5.2 -3.6 -10.2 2.1 1.2 -1.4 11.0
2010 1.7 1.0 4.2 3.3 0.7 -2.7 9.9
2011 1.1 -0.5 1.8 4.5 0.9 -1.5 7.7
2012 0.1 1.2 -1.7 2.8 0.8 -3.8 7.8
Average over economic cycles***
1979 – 1989 2.7 4.0 1.0 7.9 12.2 -0.7 2.5
1989 – 2000 2.9 3.3 1.1 3.3 8.3 -1.7 2.6
2000 – 2007 3.2 3.5 0.2 1.6 4.8 -2.2 1.8
* Pre-1997 data estimated ** Public Sector Net Borrowing (calendar years) *** Peak-to-peak for GDP relative to trend Source: ONS, Bank of England
38 UK Economic Outlook November 2013
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