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UK Economic Prospects
October 2014
Peter Spencer
Turning cautious… We’ve seen the benefits of a rebound in confidence following
the Euro crisis but now the worry list is lengthening The Scottish Referendum was not decisive and the panic
reaction in Westminster leaves a big constitutional mess This adds to the uncertainty over the outcome of the general
election, which is very hard to predict following the Clacton buy-election
The gap between the two main parties is greater than at any time since 1992, particularly on the key economic issues of fiscal retrenchment and the EU referendum.
Political stability is crucial for international investors, underpinning FDI and financing the current account deficit, which has opened up again this year, moving back to 5% of GDP
…’cause breaking up is hard to do
► As we saw in 2011 and 2015 with the €, these break-up risks are almost unfathomable and can paralyse investment
► We don’t expect paralysis this time, but investment will slow if firms begin to worry about existential risk again
► Mortgage lenders and borrowers have both become more cautious following the Mortgage Market Review and the prospective increase in interest rates
► While export growth is held back by the weakness of European markets and the weaker Euro
Remember how uncertainty about the banks and the € trashed business confidence…
40
45
50
55
60
65
70
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
Source: Haver Analytics
% balance
UK: CBI uncertainty about demand
…and the consumer
-50
-40
-30
-20
-10
0
10
20
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
Source: Haver Analytics
GfK NOP Index
UK: Consumer confidence
Mortgage lenders and borrowers have become more cautious…
-40
-30
-20
-10
0
10
20
30
40
50
60
70
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3
2012 2013 2014
UK: Secured household lending - past 3 mths% balance* tightening (-)/loosening (+) credit
Source : Bank of England Credit Conditions Survey
* supply loosening/demand rising (+) supply tightening/demand falling (-)
Still not worried? Take a look at the incoming threats on the global risk radar…
Should we still be worried by the global search for yield?
And about the tightening of US monetary policy?
Will the ongoing crisis in the ‘fragile 5’ EM’s undermine global growth?
How serious is the continued risk of a Chinese financial crisis?
Last but not least, is Europe headed for deflation?
Here we go again - compression in EM risk premia…
Monetary policy remains a major uncertainty… The low level of US and EZ interest rates compressed
yields and led to an under-pricing of risk similar to the one that led to the crunch
The Fed is nearly done tapering, prior to raising interest rates at some stage next year
But Janet Yellen has said this will be dictated by the US economy and labour market rather than global risk factors
This has given the EMs another headache, following last year’s ‘taper tantrum’
With another test to come in the form of the effect of higher US interest rates on the carry trades
Here we go again - compression in EM risk premia…
The Fed has done tapering, with the first rate hike expected in 2015H2…
0
1
2
3
4
5
6
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
US: Interest rates%
Source : EY ITEM Club
Federal Funds Rate
10-year government bond yields
Forecast
The Fed’s tightening adds to the currency problem in the EMs…
75
80
85
90
95
100
105
110
Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14
India
Indonesia
Brazil
Turkey
Emergers: Exchange rates vs. US$Index (Dec 31, 2012 = 100)
Source : Haver Analytics
Appreciation
…weakening the short-term growth outlook…
7.1
4.5
5.4
1.9
3.22.8
3.5
0.0 0.0
2.9
1.2
5.15.3
7.4
0
1
2
3
4
5
6
7
8
China India Indonesia Brazil S Africa Russia Turkey
Oct-13 Oct-14
Emerging markets: GDP growth in 2014% year
Source : EY ITEM Club
… but the EMs are in a much better place than in 1997…
World: share of disposable household income
Source: Oxford Economics.
…and long-term, the emerging market growth story is inescapable
Global risk radar…
US Monetary policy?
Will the crisis in the ‘fragile 5’ undermine global growth?
How serious is the risk of a Chinese financial crisis?
Will China suffer a banking crisis?
A crisis is not my central expectation China has over $3.6trn in reserves and government
debt is low. The government is focused on financial sector
reform. The authorities still have much greater control over
the economy than we have in the West.
However: High levels of corporate debt Excess supply of real estate. Serious questions over the ability of the Peoples’
Bank to control the growth in shadow banking. These risks may be related in ways we can’t see yet.
Forecast is for smooth rebalancing…but…
34
36
38
40
42
44
46
48
50
2003 2005 2007 2009 2011 2013 2015 2017 2019
China: Expenditure structure of GDP%
Source : EY ITEM Club
Investment
Private consumption
Forecast
…construction is still adding to the excess supply of real estate…
1.5
2.0
2.5
3.0
3.5
4.0
4.5
2006 2008 2010 2012 2014
100
200
300
400
500
600
Source : Haver Analytics
China: Excess supply in the real estate sectoryears of supply
Average 2006 - 2010
Average from 2011
Vacant floor space (rhs)
mn m²
Ratio of property under construction to sales (lhs)
…and could trigger a crisis
0
10
20
30
40
50
60
70
80
2011 2012 2013 2014
Existing
Newly constructed
Source : Haver Analytics
China: Cities experiencing house price fallsout of 70 cities
Number of cities experiencing m/m declines in residential house prices
Trade with PRC is not a serious problem for the UK…
0 20 40 60 80 100
IndiaEurozone
RussiaUKUS
ThailandJapan
MalaysiaIndonesiaSingaporePhilippines
TaiwanBrazilKorea
Australia
China share in export growth2009-13
China share in exports, 2013
World: Trade exposure to China
Source : Haver Analytics %
…and lower commodity prices have a silver lining for the UK…
0
20
40
60
80
100
120
1992-2002 2002-2012 2012-2017 (f)
Gas
Oil
Steel
Coal
China: Commodity demand% share of additional global demand for commodity
Source : Haver Analytics
... helping to subdue input costs…
65
70
75
80
85
90
95
100
105
110
115
70
75
80
85
90
95
100
105
110
115
120
125
1998 2000 2002 2004 2006 2008 2010 2012 2014
Source: Haver Analytics
2010=100
Core producer input prices(RHS)
Import prices(LHS)
UK: Import and producer input prices2010=100
…and output prices
-15
-10
-5
0
5
10
15
20
25
30
35
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
Source: Haver Analytics
% yearUK: Headline producer prices
Output
Input
Global risk radar…
US Monetary policy?
Will the crisis in the ‘fragile 5’ undermine global growth?
How serious is the risk of a Chinese financial crisis?
Europe – headed for deflation?
There’s no silver lining for he UK in the clouds hanging over the Eurozone…
The € recovery has stalled in Q2, with the Ukraine having a surprisingly large effect on confidence…
But Mario Draghi has successfully devalued the €
This has fallen back from $1.43 to $ 1.26
This helps fight deflation by raising import costs
And boosting € zone exports
But at the expense of US and UK exporters!
Recovery stalls in Q2…
-8
-6
-4
-2
0
2
4
6
1999 2001 2003 2005 2007 2009 2011 2013
Source : Haver Analytics
Eurozone: GDP% year
FranceSpain Germany
Italy
Ukraine has damaged sentiment…
0
2
4
6
8
10
12
14
16
18
Lat Est Fin Sla Aus Ger Ita SlRep
EZ Fra Net Bel Spa Gre Ire Por
Percent of total exports
Percent of GDP
Source : Haver Analytics
Eurozone: Exports to Russia in 2013%
0
1
2
3
4
5
6
7
Aus Ita Fra Net Ger Bel Gre Spa Por
Percent of total foreign exposure
Percent of GDP
Source : Haver Analytics
Eurozone: Banks' exposure to Russia%
Low inflation and the large output gap means deflation risk…
-5
-4
-3
-2
-1
0
1
2
3
4
5
2005 2007 2009 2011 2013 2015 2017
Eurozone: Output gap% of potential output
Source : EY ITEM Club
Forecast
But Draghi has successfully deflated the €, which helps stave off deflation and bodes well for European exporters…
98
99
100
101
102
103
104
105
106
Jan 13 Apr 13 Jul 13 Oct 13 Jan 14 Apr 14 Jul 14
1.25
1.27
1.29
1.31
1.33
1.35
1.37
1.39
1.41
1.43
1.45
Source : Haver Analytics
Eurozone: Exchange ratesIndex - Q1 1999 = 100 $/€
$/€ (RHS )
Nominal effective exchange rate (LHS )
This points to steady but unspectacular growth
-3
-2
-1
0
1
2
3
4
5
6
2010 2011 2012 2013 2014 2015 2016
Eurozone: GDP% year
Source : EY ITEM Club
Germany
France
Italy
Spain
Forecast
..but with no support from fiscal policy
-0.5
0.0
0.5
1.0
1.5
2.0
2011 2012 2013 2014 2015 2016 2017 2018
Source : IMF
Eurozone: Fiscal stancePercentage point
Annual change in the structural budget deficit
Forecast
Global forecast summary
2.72.1
0.8 0.9
7.4
2.62.0
0.8 0.9
7.2
0
1
2
3
4
5
6
7
8
World US Eurozone Japan China
Baseline Risk-weighted
Global GDP forecasts - 2014% year
Source : EY ITEM Club
3.0 3.2
1.51.0
6.9
2.62.9
0.9 0.7
6.1
0
1
2
3
4
5
6
7
8
World US Eurozone Japan China
Baseline Risk-weighted
Global GDP forecasts - 2015% year
Source : EY ITEM Club
Global risk roundup
The US monetary policy tightening has been problematic for EMs
But Asia is less risky than in 1997 and the long run growth story is inescapable
The stronger US economy and dollar now helps the Eurozone And of course UK exporters
.
The latest UK data show a much stronger recovery…
This month’s ONS data revisions give a very different perspective on the shape of the recession – and recovery
GDP has been revised up, meaning that we passed the previous peak a year ago and output is well above the 2008 peak
This is more consistent with the strong growth in employment, although productivity has still fallen
The upward revision in investment has been particularly pronounced, meaning the need to catch up for the low levels of the recession is less than previously thought
…and put the UK in an expansion phase
They give a very different picture for investment…
70
75
80
85
90
95
100
105
110
2006 2007 2008 2009 2010 2011 2012 2013 2014
UK: Business investment revisionsRebased, Q1 2008 = 100
Source : Haver Analytics
New
Old
..but show much smaller revisions for consumption
93
94
95
96
97
98
99
100
101
2006 2007 2008 2009 2010 2011 2012 2013 2014
UK: Consumer spending revisionsRebased, Q1 2008 = 100
Source : Haver Analytics
New
Old
But where is next year’s growth coming from?
The labour market remains strong and flexible and we expect consumer incomes to be buoyed up by rising employment
Employment growth should slow but wages should pick up a bit as unemployment falls and the labour market tightens
Financial conditions favour investment and firms are still catching up with the effect of the recession on the capital stock
We expect GDP to growth to ease back to 2.4% next year after 3.1% this year, with interest rates on hold until next spring
Consumption is constrained by weak wages and the need to save…
The recovery in real incomes and consumption has been founded on employment rather than wage growth
This has been reinforced an improvement in job security and consumer confidence, encouraging people to reduce rates of precautionary saving and to go out and spend
However, savings ratio has now fallen back to around 6%, just about consistent with a stable debt to income ratio of around 1.4
Pension pressures and the prospect of higher interest rates likely next year should stop the saving ratio from falling further
And the FPC will also be keen to prevent rising debt ratios Meaning that the growth in consumption must move back
towards the growth in household disposable incomes
The FPC will be watching these ratios…
4
5
6
7
8
9
10
11
12
2002 2004 2006 2008 2010 2012 2014 2016 2018
UK: Savings ratio% of disposable income
Source : EY ITEM Club
Forecast
…and especially this one this one…
110
120
130
140
150
160
170
2002 2004 2006 2008 2010 2012 2014 2016 2018
UK: Household debt-to-income ratio% of household disposable income
Source : EY ITEM Club
Forecast
…very closely
20
40
60
80
100
120
140
160
180
200
1990 1993 1996 1999 2002 2005 2008 2011 2014 2017
Source: Oxford Economics
Forecast
1995=100
Mortgage interest payments/income
Houseprices/incomes
UK: Housing ratios
This is where the growth is coming from…
-1.5
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
1997-2007
2012 2013 2014 2015 2016 2017 2018
Consumer spending Investment
Govt. consumption Inventories
Net trade
UK: Contributions to GDP growth%pts
Source : EY ITEM Club
ITEM Club UK Autumn forecast 2014
The EY ITEM Club forecast for the UK economy, Autumn 2014
% changes on previous year except borrowing, current account and interest & exchange rates
GDPDomestic Demand
Consumer spending
Fixed investmen
t Exports Imports2012 0.7 1.4 1.1 0.7 0.7 3.12013 1.7 1.9 1.6 3.2 0.5 0.52014 3.1 3.1 2.1 9.3 -0.3 -0.42015 2.4 2.8 2.3 7.5 5.1 5.42016 2.3 2.5 2.2 7.8 5.2 5.52017 2.5 2.3 2.0 7.3 5.1 4.22018 2.5 2.1 1.8 6.2 5.1 3.7
Net Govt Borrowing
(*)
Current account
(% of GDP)
Average earnings CPI Bank Rate
Effective exchange
rate2012 7.2 -3.7 2.4 2.8 0.5 83.02013 5.6 -4.2 1.4 2.6 0.5 81.52014 5 -4.6 1.1 1.6 0.5 87.22015 3.9 -3 2.1 1.3 1.1 87.42016 2.4 -2 2.8 1.5 2.1 86.42017 1.0 -1.6 3.3 2.0 3.1 85.52018 0.1 -1.2 3.8 2.2 3.5 84.7
Summary
Uncertainty is now likely to slow UK investment The weakness of wages constrains the consumer, but employment
growth remains strong The export outlook remains poor, particularly in Europe, given the fall in
the €. But falling commodity prices should give the advanced economies a significant boost, especially large oil importers like the Eurozone and Japan.
In the UK, they have sharply reversed the inflationary pressures of recent years, taking CPI inflation down to 1.2%
I expect GDP to grow by 3.1% this year and 2.4% in 2015, with interest rates on hold until next spring at the earliest, depending on how these risks play out