UK Economic Outlook

CHC Conference, 11th July 2019

Professor Trevor Williams

University of Derby

Agenda:

• UK economic outlook –Brexit and beyond

• Conclusions

• Money supply growth is weakening, partly due to Brexit uncertainty but also a global cycle and longevity of current expansion. Price inflation is falling, so the UK can hold rates. With inflation adjusted interest rates negative, the BOE may not have to cut nominal rates.

• Economic growth was revised lower from 1.6% to 1.2% for 2019. Inflation is forecast at or below target for the next few years. UK not in bad shape in global advanced economy context.

• Public finances again surprised on the upside, with forecasts improving even on the big gains we saw back in October. Borrowing is set to come in at just £23 billion this year. At 1.1% of GDP that’s its lowest level since 2001-02.

• The deficit is lower than forecast a year ago, but still higher than forecast in March 2016: £32 billion higher in 2020–21.

• If total spending doesn’t rise as a fraction of national income we are now perhaps only 20 years from the moment when half of all state spending goes on just health, pensions and social care. It was 30% at the turn of the century.

• Tax is currently at its highest sustained level as a fraction of national income since the early 1950s.

• OBR forecasts are all predicated on a fairly smooth transition to Brexit, certainly not on crashing out of the EU without a withdrawal agreement.

SUMMARY

2

UK FORECASTS:

PREPARING FOR BREXIT

A BREXIT EFFECT ALREADY EVIDENT?

4

CONSERVATIVE MEMBERS ARE HARDCORE LEAVERS

Source: YouGov 11-14 June 2019

SLIDO / AUDIENCE QUESTIONS

A) would you vote for Brexit if vote held now? yes or no

if so, would you vote for Brexit if it meant:

a) Scotland left the unionb) NI left the unionc) It damaged the economyc) Corbyn became PM?

A BREXIT EFFECT ALREADY EVIDENT?

6

BRING ON PRIME MINISTER BORIS JOHNSON?

Race for the Leadership of the Tory Party, You Gov, survey of 858 party members, % share

AND THEN THERE WERE 2!

Source: YouGov, June

A BREXIT EFFECT ALREADY EVIDENT?

7

A POINTLESS EURO ELECTION?

Or a pointer to a referendum or general election outcome?

Source: FT, June 16

AN INCONVENIENT TRUTH

Trust in the EU is higher than for national governments and rising

Source: Eurobarometer

8

IT WILL BE HARD FOR US TRADE TO REPLACE THE EU’S

9

• Trade with the EU is 47% of UK exports. The EU’s exports to the UK account for 14% of its total.

• The EU trades more with the rest of the world than does the UK.

• The EU’s share of trade with the US is higher than the UK’s share

Although china’s economy is $7trln smaller (20.5 to 13.5) than the US, it is almost as big an importer.

Sources: ONS & TW calculations.10

AND IN A TRADE WAR EVERYONE LOSES…

UK OUTPUT AND EMPLOYMENT ARE EXPECTED TO FALL SHARPLY IN A ‘NO DEAL, NO TRANSITION’ BREXIT

Source: Bank of England, (a) Companies were asked ‘Relative to the last 12 months, what is the likely impact on the following for your business over the next year in each scenario: (a) a deal and transition period and (b) no deal and no transition period?’ For each relevant business factor, respondents were asked to choose between ‘Fall greater than 10%’; ‘-10 to -2%’; ‘Little change’; ‘+2 to +10%’ and ‘Rise greater than 10%’. (b) Net percentage balances of companies reporting increases or declines in each factor, weighted by employment. Half weight was given to the ±2%–10% response and full weight was given to those that responded ‘Rise/Fall greater than 10%’.

11

..EVEN THOUGH MOST FIRMS IMPACTED HAVE CONTINGENCY PLANS…

Source Bank of England Agents surveys:

(a) Companies were asked ‘How advanced is your contingency planning for a ‘no deal and no transition’ Brexit?’.

(b) The question asked about ‘plans for the end of March 2019’. 12

WHAT ABOUT THE CURRENT STATE OF THE ECONOMY?

10 YEARS ON FROM LEHMANS’S COLLAPSE: HAS POLICY WORKED?

• Record low interest rates

• Vast amounts of QE

• Bank bailouts

• Fiscal stimulus

• How do we measure success in terms of economic recovery?

• When will economic conditions and financial markets return to ‘normal’?

14

NET FINANCIAL WEALTH HAS RISEN SHARPLY SINCE 2008…

15

Source: ONS, TW consultancy

…BUT REAL INCOME GROWTH STAGNATES

-1 0 1 2 3

UK

Canada

US

OECD average

France

Italy

Germany

Japan

Annual %, real 2007 2017 No wonder voters

are unhappy, particularly in the US, UK, and Italy?

Source: OECD, constant prices16

HOWEVER, THE ECONOMY HAS RECOVERED STEADILY SINCE 2012…

17

Source: TW consultancy, ONS projections

BUT THE UK GOVERNMENT HAS REVISED DOWN ITS FORECASTS…

18

Outturn

2018 2019 2020 2021 2022 2023

GDP growth (per cent) 1.4 1.2 1.4 1.6 1.6 1.6

Main contributions

Private consumption 1.1 0.7 1.0 1.1 1.1 1.1

Business investment -0.1 -0.1 0.2 0.2 0.2 0.2

Dwellings investment1 0.1 0.0 0.0 0.0 0.1 0.1

Government2 0.1 0.5 0.4 0.4 0.3 0.4

Change in inventories 0.3 0.4 0.0 0.0 0.0 0.0

Net trade -0.2 -0.5 -0.2 -0.1 -0.1 -0.2

Other3 0.1 0.0 0.0 0.0 0.0 0.0

Note: Components may not sum to total due to rounding.

Percentage points, unless otherwise stated

Forecast

1 The sum of public corporations and private sector investment in new dwellings, improvements to dwellings and transfer costs.2

The sum of government consumption and general government investment.3 Includes the statistical discrepancy and net acquisition of valuables.

Source: Bank of England

19

UK AND GLOBAL GROWTH MAY HAVE STEADIED IN Q1 2019

• Sources: Eikon from Refinitiv, IMF WEO, National Bureau of Statistics of China, OECD, ONS and Bank calculations.

• (a) Real GDP measures. Figures in parentheses are shares in UK exports in 2017. (b) The 1998–2007 average for China is based on OECD estimates. Estimates for 2008 onwards are from the National Bureau of Statistics of China. (C) The earliest observation for Russia is 2003 Q2. (d) As defined in footnote Figure for 2019 Q1 is a Bank staff projection.

20

OUTPUT GROWTH SLOWS FURTHER IN 2019

Source: Bank of England

(a) Chained-volume measures at basic prices. Figures in parentheses are weights in nominal GVA in 2016. Contributions may not sum to the total due to rounding. (b)Other production includes utilities, extraction and agriculture.

21

UK FORECASTERS THINK THE CHANCES OF SUB 1% GROWTH ARE HIGH

Averages of forecasters’ probabilities attached to GDP growth outturns in three years’ time

Sources: Projections of outside forecasters provided for Inflation Reports between February 2007 and May 2019.

With business investment particularly weak

22Source: Bank of England

BUSINESS INVESTMENT SPENDING HAS BEEN VERY WEAK SINCE 2016

Customer funding gap has narrowed(a)

23

BUSINESS SURVEYS SHOW OUTPUT IS EXPECTED TO STAY WEAK

Sources: BCC, CBI, IHS Markit, Lloyds Banking Group and Bank calculations. (a)Net percentage balance of respondents in the non-services and services sectors reporting they expect turnover to increase over the next year, weighted together using output shares. Data are not seasonally adjusted. Differences from average since January 2000. (b) Net percentage balance of respondents with turnover over £1 million that expect business activity to increase over the next year. Differences from average since January 2002.(c) Net percentage balance of respondents from the manufacturing, distribution, consumer, business and professional services sectors reporting that they expect output to increase in the next three months weighted together using output shares. Differences from average since October 2003.d) Net percentage balance of respondents expecting business activity to rise over the next year (service and construction) or reporting that new orders have increased over the month (manufacturing), weighted together using output shares. Differences from averages since January 2000.

UK M4 GROWTH TREND IS STILL SLOWING RAPIDLY, T0 A 2011 PACE…

Saved from: https:/ / www.bankofengland.co.uk/ boeapps/ database/ ShowChart.asp?html.

x=yes&Datefrom=01/ Jan/ 2011&Dateto=&frequency=&SeriesCodes=RPMB56Q,RPMB62Q&UsingCodes=Y&VPD=Y&VFD=N&label1=Money&label2=Lending&label3=&label4=&label5=&tabular=N&axis=Per%20cent%20changes%20on%20a%20year%20earlier&stacked=N&bar=N

24

But borrowing has accelerated in recent months even as money supply growth slows

Sources: Bank of England.

25

14/04/2019 Money and Credit - February 2019 | Bank of England

https://www.bankofengland.co.uk/statistics/money-and-credit/2019/february-2019 3/4

Bank lending to large businesses increased by £1.1 billion in February, but was below the recent average of £2.0

billion. In contrast, lending to small and medium sized businesses (SMEs) fell slightly by £0.1 billion. These weaker

flows have resulted in the growth rates for business lending falling for both large businesses and SMEs, to 5.6% and

0.2% respectively (Chart 2).

Chart 2: Bank lending to businesses growth

Seasonally adjusted

Broad money (Table J)

The total amount of money held by UK households, private non­financial corporations (PNFCs) and non­intermediary

other financial corporations (NIOFCs) (broad money or M4ex) increased by £3.6 billion in February (Chart 3). The

increase was more than accounted for by households’ money holdings which increased by £5.3 billion, above the £3.3

billion average of the previous six months. This strength was mainly due to continued strength in instant access

interest bearing savings accounts. Money holdings by PNFCs and NIOFCs fell back slightly in February.

Chart 3: Sectoral split of M4ex

Seasonally adjusted

Summary tables

Annual growth of bank lending to businesses fell in February for large business and SMEs, reversing increases in January. Total is under 4% pa.

LARGE FIRMS ARE BORROWING BUT SME’S ARE NOT

With business investment particularly weak

Sources: Bank of England.

26

Saved from:

https:/ / www.bankofengland.co.uk/ boeapps/ database/ ShowChart.asp?html.

x=yes&Datefrom=01/ Jan/ 2011&Dateto=&frequency=DD&SeriesCodes=LPMVVUZ,LPMB4TQ,LPMB4TC&UsingCodes=Y&VPD=Y&VFD=N&label1=Credit%20cards&label2=Other%20loans%20and%20advances&label3=Total&label4=&label5=&tabular=N&axis=Per%20cent%20changes%20on%20a%20year%20earlier&stacked=N&bar=N

Annual growth of consumer lending

• The annual growth rate of consumer credit has been slowing gradually since its peak November 2016, falling further towards 6% in March.

• Within this, the growth rate of credit card lending, which had until recently been fairly stable, fell closer to 6%.

• The growth rate on other loans and advances, which has been declining since December 2016, also fell further towards 6%.

CONSUMERS ARE BORROWING AT A SLOWING PACE

27

Source: Bank of England

A. Saving as a percentage of household post-tax income. Includes NPISH.

BUT UNEMPLOYMENT HAS FALLEN TO 1975 LOWS, BRINGING DOWN HOUSEHOLD SAVINGS…

Sources: ONS & TW calculations.

-25.0

-20.0

-15.0

-10.0

-5.0

0.0

5.0

10.0

15.0

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0 % increase in year

GDP Households

Government spending Gross fixed capital formation, rhs

% increase in year

28

..HELPING TO MAINTAIN HOUSEHOLD SPENDING GROWTH EVEN THOUGH ITS SLOWED…

..TH=AT SLOWDOWN IS PARTLY BECAUSE HOUSE PRICE INFLATION HAS STAGNATED…

Sources: HM Land Registry and Bank calculations.

(a) Data for Northern Ireland are available on a quarterly basis up to 2018 Q4 and are seasonally adjusted by Bank staff.

29

• Reducing affordability.

• Regulatory and tax changes since 2014.

• The slowing in the buy-to-let market

• A fall in net EU migration*• Wider Brexit uncertainty.• But growth in incomes, low rates

and low unemployment should offer support.

• The number of EU nationals in London appears to have fallen since the EU referendum, although it has continued to grow in other regions.

• EU nationals make up around 12% of households in London and 20% of the private rental sector, that fall will affect demand for housing services and therefore house prices and rents.

WHY THE FALL?

…AS HOUSE PRICE INFLATION HAS BEEN CORRELATED WITH CONSUMPTION IN THE PAST

Sources: HM Land Registry, ONS and Bank calculations.

(a) Real house prices are calculated as the UK house price index divided by the consumer expenditure deflator (including NPISH).

(b) Chained-volume measure, including NPISH.

31

…BUT INVESTMENT IN NEW NEW BUILDS AND STARTS IS STILL RISING

• Sources: Ministry of Housing, Communities and Local Government, ONS and Bank calculations.(a) Chained-volume measure, 2016 prices. Excludes major repairs and improvements to existing dwellings.(b) Number of permanent dwellings started/completed by private enterprises up to 2018 Q3 for England and Northern Ireland. Data from 2011 Q2 for housing starts in Wales and from 2018 Q3 for housing starts and completions in Scotland have been grown in line with permanent dwelling starts/completions by private enterprises in England. Data are seasonally adjusted by Bank staff.

32

…HOWEVER, THERE IS A STRUCTURAL HOUSING CRISIS BECAUSE TOO FEW HOMES HAVE BEEN BUILT…

• Sources: Ministry of Housing, Communities and Local Government, ONS and Bank calculations.(a) Chained-volume measure, 2016 prices. Excludes major repairs and improvements to existing dwellings.(b) Number of permanent dwellings started/completed by private enterprises up to 2018 Q3 for England and Northern Ireland. Data from 2011 Q2 for housing starts in Wales and from 2018 Q3 for housing starts and completions in Scotland have been grown in line with permanent dwelling starts/completions by private enterprises in England. Data are seasonally adjusted by Bank staff.

33

…AND HOUSE PRICE INFLATION HAS OUTPACED EARNINGS GROWTH

• Sources: tfw

Indicators of consumer confidence

(Sources: GfK (research carried out on behalf of the European Commission) and Bank calculations.(a) Net balances of respondents expecting that the number of people unemployed will rise over the next 12 months. (b) Net balance of respondents reporting that they expect their personal financial situation or the general economic situation to improve over the next 12 months. 34

ALTHOUGH HOUSEHOLD CONFIDENCE HAS DIPPED FEWER WORRY ABOUT THEIR OWN FINANCIAL POSITION…

AND THE UK HOUSEHOLD DEBT TO INCOME RATIO HAS STABILISED AT A HIGH LEVEL…

Source: Bank of England Financial Stability Report (2018)

(https://www.bankofengland.co.uk/-/media/boe/files/financial-stability-report/2018/june-2018.pdf)

The problem is that it is hard to understand and predict a credit bust (or a boom, for that matter)

w ithout the right tools – in our case: the right models. Since the fina ncial crisis, many economists

have made up for lost time by developing a huge arsenal of new models that boast features from

housing, to fixed interest rate mortgages, to non-linear effects. H owever, when looking at each of

these factors in isolation, none of them alone can explain the evolution of mortgage debt. We address

this problem in a recent w orking paper (https://w w w.bankofengland.co.uk/working-

paper/2018/multi-period-loans-occasionally-binding-constraints-and-monetary-policy-a-

quantitative-evaluation), in which we construct a model that includes several such features and

allow s us to replicate and explain the nature of the mortgage debt boom-bust cycle. The paper also

show s that the transmission of monetary policy depends on the stage of the housing cycle and the

length of fixed interest rate mortgages.

Modelling non-linear effects and fixed interest rates is essential to explain the data on mortgage

debt

A standard macro model w ith housing (https://w w w.aeaweb.org/articles?id=10.1257/mac.2.2.125)

often assumes that mortgages last for only one period. It might sound counter-intuitive to assume

that a loan is continuously taken out and repaid every period, but as mortgages in these models

always have variable interest rates, it is not as unrealistic of an assumption as it sounds. It is

equivalent to taking out a mortgage each period and paying the current interest rate.

We expand upon this model by making three crucial and realistic extensions: (i) Loans can be held for

longer than one period. To make things more interesting these mortgages can be taken out as fixed

interest rate mortgages. This means that the interest rate on the mortgage is not affected by changes in

the central bank’s interest rate for a specific duration of time. There is a large variation among

countries in how long the fixed rate period can last, w ith the US on the longest side of the spectrum

w ith an average duration for which the interest rate of a mortgage is fixed of around 27 years

(http://w w w.nber.org/papers/w18339.pdf) (see Figure 2), and the UK on the shorter side of the

spectrum w ith an average duration of fixed interest rate mortgages of only 3 years.

Source: Bank of England Financial Stability Report (2018)

35

PUBLIC SECTOR NET DEBT HOLDS NEAR RECENT PEAK…

36

…AS THE POPULATION AGES…

37

Source: TW consultancy, ONS projections

0

2

4

6

8

10

12

14

2019 2024 2029 2034 2039

working age

Pensionable age

% increase in period• Growth of those of

pensionable age will outstrip that of the working population by 3 to 1 in 20 years, so spending will rise sharply come what may.

• How to pay –higher taxes, faster growth or…?

38

Source: Bank of England

STERLING HAS CHANGED VERY LITTLE SINCE ITS 2016 DEPRECIATION

BUT PRICE INFLATION HAS DROPPED TO BELOW THE 2% TARGET…

39Source: ONS.

MPC 2% inflation target

-1

0

1

2

3

4

5

6

May

20

09

Au

g 2

00

9

No

v 2

00

9

Feb

20

10

May

20

10

Au

g 2

01

0

No

v 2

01

0

Feb

20

11

May

20

11

Au

g 2

01

1

No

v 2

01

1

Feb

20

12

May

20

12

Au

g 2

01

2

No

v 2

01

2

Feb

20

13

May

20

13

Au

g 2

01

3

No

v 2

01

3

Feb

20

14

May

20

14

Au

g 2

01

4

No

v 2

01

4

Feb

20

15

May

20

15

Au

g 2

01

5

No

v 2

01

5

Feb

20

16

May

20

16

Au

g 2

01

6

No

v 2

01

6

Feb

20

17

May

20

17

Au

g 2

01

7

No

v 2

01

7

Feb

20

18

May

20

18

Au

g 2

01

8

No

v 2

01

8

Feb

20

19

May

20

19

% increase in year

CPIH CPI

40

Source: ONS, TW consultancy

BUT:• £494 per week in nominal terms (that is, not adjusted for price inflation), is up from £478 per week the year earlier.• £464 per week in constant 2015 prices (that is, adjusted for price inflation), up from £458 per week for a year

earlier, but £8 lower than the pre-downturn peak of £473 per week in 2008.

…SO BOOSTING REAL PAY GROWTH TOWARDS ITS PRE CRISIS PEAK…

Page 7 of 13

Earnings growth

Figure 4: Pay for employees (including bonuses) increased by 1.6% on the year when adjusted for

inflation

Average weekly earnings annual growth rates, seasonally adjusted, Great Britain, January to March 2001 to December 2018 to

February 2019

Source: Office for National Statistics – Monthly Wages and Salaries Survey

The are not just a measure of pay rises as they also reflect changes in the number of paid earnings estimateshours worked and changes in the structure of the workforce; for example, more high-paid jobs would have an upward effect on earnings growth rates.

Earnings in real terms (that is, adjusted for inflation) is calculated as nominal earnings (that is, not adjusted for

inflation), deflated by the Consumer Prices Index including owner occupiers’ housing costs (CPIH).

Between December 2017 to February 2018 and December 2018 to February 2019 for employees in Great Britain:

regular pay was estimated to have increased by 3.4% in nominal terms and by 1.5% in real terms

total pay was estimated to have increased by 3.5% in nominal terms and by 1.6% in real terms

More information about earnings growth can be found in the bulletin, Average weekly earnings in Great Britainpublished alongside this release.

Pre crisis trend +2% pa

Post crisis trend -0.2%

Sources: Bloomberg Finance L.P., projections of outside forecasters provided for Inflation Reports in November 2018 and February 2019 and Bank calculations.(a) Estimated using instantaneous forward overnight index swap rates in the 15 working days to 24 October 2018 and 30 January 2019 respectively.

41

AND MEANS UK INTEREST RATES CAN BE CUT IN A CRISIS

CONCLUSIONS

42

UK firms are preparing for Brexit. But uncertainty persists. A general elcetion, / referendum all seem equally likely

UK economy is reliant on consumer spending to maintain momentum. Business investment remains weak.

But weak economic growth means low price inflation and so allows for even lower interest rates. Public and private debt levels remain

high.

A Brexit effect from ‘uncertainty’ seems evident

The world economy is slowing. And so is the UK, but by more.