uk economic outlook july 2012

UK Economic OutlookJuly 2012

www.pwc.co.uk

Feature articles:•The UK housing market: What’s coming next and what does it mean?•Historic performance and future prospects for the UK relative to other G7 economies

PwC firms help organisations and individuals create the value they are looking for. We’re a network of firms in 158 countries with close to 169,000 people who are committed to delivering quality in assurance, tax and advisory services. Tell us what matters to you and find out more by visiting us at www.pwc.com.

This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers LLP, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

UK Economic Outlook July 2012 3

Highlights and key messages for business and public policy

• In our main scenario we project GDP growth of around zero in 2012 as a whole, but picking up later in the year and rising to 1.7% in 2013. As our new UK business climate map in Figure 1.1 shows, this ‘cloudy but improving’ outlook is mirrored in many UK regions, though the sunshine may come through a bit sooner in London and the South East than in some other parts of the country. The growth figures in the map are averages for 2012 and 2013 to smooth out short-term variations, while the weather symbols also take account of recent employment trends in each region. The Eurozone average is also shown in the map for comparison.

• Risks around growth in our main scenario are weighted to the downside at present given the ongoing challenges in the Eurozone. We therefore recommend that businesses should stress test their plans and valuations against an alternative ‘prolonged recession’ scenario. However, there will also be upside possibilities if the difficult period of the next few months can be safely navigated.

• We expect real consumer spending growth of around 0.1% in 2012 and around 1.3% in 2013 as inflation falls back, easing the squeeze on real household incomes that led to a 1.1% fall in real consumer spending in 2011. Structural shifts towards online spending will continue to pose significant challenges for traditional high street retailers.

• Business investment figures have been revised up significantly recently and should enable total fixed investment to make a positive contribution to growth in both 2012 and 2013, despite the weakness of government investment. Company finances are relatively healthy, particularly for larger firms, so these companies should be able to invest more if current uncertainties related to the Eurozone crisis can be overcome, or at least reduced over time.

• Consumer price inflation should fall back towards its 2% target level over the next year as earlier global commodity price increases have been reversed in recent months and as UK earnings growth remains subdued.

• The UK housing market looks set to remain relatively flat over the next couple of years but should recover later in the decade as confidence is gradually restored, credit conditions ease for first time buyers and underlying supply shortages reassert themselves. But it could still be after 2020 before real house prices return to pre-crisis peak levels.

Figure 1.1 – UK business climate map

Source: ONS, Eurostat, PwC analysis based on latest data available as of 28 June 2012.Note: Eurozone employment rate is from 2011; figures on employment levels in early 2012 show falling employment.

Estimated average GDP growth in 2012 and 2013 / Latest Employment rateUK outlook – cloudy but improving

Scotland

North West

Northern Ireland

North East

Wales

Yorkshire & Humberside68.60.5%

67.10.4%

66.50.5%

68.00.5%

68.90.8%

South West

East Midlands

73.20.8%

71.90.8%

South East

West Midlands

74.81.3%

London

East

74.90.7%

70.60.8%

Eurozone – still stormy

64.20.0%

71.10.7%

68.70.8% 67.71.1%

increasing employment rate no change in the employment rate falling employment rate

• The UK outperformed most of its G7 peer group in terms of growth, inflation and unemployment in the decade leading up to 2007, but has since lagged behind most other G7 economies in growth while inflation has been relatively high.

• We believe, backed up by analysis by the IMF and others1, that this relative under-performance is more likely to be a correction to unsustainably strong pre-crisis performance rather than an indication that UK growth will permanently lag behind the G7 norm, or that UK inflation will be permanently higher.

• But effective supply side reforms will be critical to improving relative UK performance in the medium term, particularly in relation to productivity growth. These measures need to include a more comprehensive programme of tax reform together with increased investment in infrastructure, innovation and skills.

1 See Section 4 for details.

UK Economic Outlook July 20124

Contents

Section Page

1 Summary 05

2 UK economic prospects 08

• 2.1 Recentdevelopmentsandthepresentsituation 08• 2.2 Economicgrowthprospects 11• 2.3 Outlookforinflation 13• 2.4 Fiscalandmonetarypolicyoptions 14• 2.5 Summaryandconclusions 15

3 The UK housing market: What’s coming next and what does it mean? 16

• 3.1 Recentdevelopmentsinthehousingmarket 16• 3.2 TheoutlookforUKhouseprices 17• 3.3 Financingahousepurchasewithdebtisbecomingmoredifficultandcostly 19• 3.4 Ashortageofhousingiskeepingpriceshigh 21• 3.5 Youngpeoplearehavingtowaitlongertobuyhouses 23• 3.6 Weneedastrongersupplyoflong-termrentalproperty 24• 3.7 Incentivestousethespacethatexistsmoreeffectivelycouldhelpmitigatetheshortageofhousing 25• 3.8 Houseswillremainamajorsourceofhouseholdwealth-thereislikelytobeincreasingdemandtounlockit 25• 3.9 Summaryandconclusions 26• 3.10Appendix 26

4 Historic performance and future prospects for the UK relative to other G7 economies 27

• 4.1 Ahistoricalreviewofeconomicperformance:UKvs.otherG7economies 27• 4.2 Futureprojections:UKvs.otherG7economies 31• 4.3 Policyimplicationsandconclusions:wheredowegofromhere? 32

Appendices

AOutlookfortheglobaleconomy 35BUKeconomictrends:1979-2011 36

Contacts and Services 37


Recent developments

The UK economy contracted by 0.4% in the last quarter of 2011 and by a further 0.3% the first quarter of 2012 according to latest official estimates. Services growth was modest during these two quarters while manufacturing and construction output fell back. Consumer spending remained constrained while the Eurozone crisis dampened exports and discouraged new business investment. These are still only preliminary estimates, but it does seem that the UK economy has – excluding short term fluctuations – been broadly flat for the past 18 months.

Most recent business surveys have been a little more encouraging, suggesting some pick up in services in the first five months of the year, modest growth in construction and a smaller fall in manufacturing than suggested by the official data. Labour market statistics also point to a slightly stronger picture than the official GDP data. However, the economy is likely to have weakened in the second quarter of 2012, even excluding the impact of the extra Diamond Jubilee bank holiday, given the difficult international environment with continuing high levels of uncertainty about prospects for the Eurozone.

On the other hand, the US has recorded modest growth since mid-2011 and growth remains reasonably strong in China, albeit with some slowdown from earlier very rapid rates of expansion in this and other emerging markets. Oil prices have fallen back markedly in recent months due to

slowing global growth, which has helped to mitigate inflationary pressures in the UK and elsewhere. Headline UK inflation is now back below 3% and seems to be on a gradual declining trend.

The Bank of England resumed its quantitative easing programme last October and chose to extend this further in February and again in early July in response to weaker than expected growth and falling inflation. In addition, measures to improve banking sector liquidity and funding for lending were announced by the Treasury and the Bank of England in June to offset risks of a renewed credit crunch due to the fall-out from the Eurozone crisis.

Future prospects

Our main scenario sees UK GDP being broadly flat on average in 2012 as a whole, but with a pick-up in growth in the second half of the year after declines in GDP in the first half of 2012. This gradual upturn is expected to carry through to growth of around 1.7% in 2013 in our main scenario (see Table 1.1).

As shown in Table 1.1, our main scenario for growth in 2012-13 is somewhat lower than the forecasts of the Office for Budget Responsibility (OBR), which were made in March before disappointing Q1 2012 GDP data were published. Our view is more in line with the latest consensus projections, which have trended down in recent months as the Eurozone crisis has reignited and will probably fall further over the next few months. However, both our main scenario

1 – Summary

Projected % change on a year earlier

Figure 1.2 – Alternative GDP growth scenarios

-8

-6

-4

-2

0

2

4

Main Source: ONS, PwCStrong recoveryProlonged recession

Scenarios

Source: Office for Budget Responsibility (March 2012), HM Treasury survey of independent forecasts (average values in June 2012 survey)and PwC main scenario. Investment refers to total fixed investment by both business and government. CPI inflation rates are annual averages.

Indicator OBR forecasts Independent PwC(% change on previous year) (March 2012) forecasts Main scenario (June 2012) (July 2012) 2012 2013 2012 2013 2012 2013

GDP 0.8 2.0 0.3 1.7 0.0 1.7

Consumer spending 0.5 1.3 0.5 1.3 0.1 1.3

Investment -0.3 6.2 0.3 3.8 2.8 3.6

CPI 2.8 1.9 2.8 2.1 2.9 2.2

Table 1.1 – Summary of UK economic prospects

and the projections of other forecasters are subject to significant margins of uncertainty, as indicated by the alternative GDP growth scenarios shown in Figure 1.2.

We project consumer spending to rise slightly faster than overall GDP growth on average in 2012, but somewhat slower than GDP in 2013, which is consistent with the

views of most other forecasters. This is due to subdued prospects for earnings growth and house prices and the drag from high household debt levels and public sector job cuts. But lower price inflation should help consumers to avoid a repeat in 2012-13 of the sharp cut in real spending they were forced to make in 2011.

% per annum on average over periods shown

Figure 1.4 – Real GDP growth in G7 economies since 1997

Source: OECD, ONS

-6

-5

-4

-3

-2

-1

0

1

2

3

4

UKUSJPNITAGERFRACANUKUSJPNITAGERFRACANUKUSJPNITAGERFRACAN

Expansion(1997 Q4 - 2007 Q4)

Recession(2008 Q1 - 2009 Q2)

Recovery(2009 Q3 - 2012 Q1)

0.9%

2.4%2.1%

0.4%

2.9%

1.3%

2.8%

-4.2%

-3.5%

-4.8%-4.5%

-3.7%

-2.7%-2.5%

3.1%

0.9%1.4%1.6%

2.8%

2.2%

3.2%


Fixed investment has been revised up recently, particularly in the case of business investment, and should bounce back further over the next 18 months given that company finances appear relatively healthy at present (at least for large firms). However, investment is still being held back by the overhang of uncertainty from the Eurozone crisis and the fact that, where businesses do want to invest, they may focus more on faster growing emerging markets. Nonetheless, replacement investment should be required in the UK so we do expect some positive growth in this area in both 2012 and 2013.

Inflation, both in terms of CPI and RPI, is expected to moderate steadily over the rest of this year, with CPI inflation moving back to around its 2% target rate during 2013. The MPC should be able to keep interest rates on hold for the next year or so given the fragility of the recovery. It could yet decide to implement additional quantitative easing or other unconventional measures if growth is slower than we expect, although this would not be required in our main scenario.

Risks to growth remain significant and still appear to be biased to the downside in the short term. We therefore recommend that businesses should stress test their plans against a ‘prolonged recession’ scenario in which GDP falls further over the next year as shown in Figure 1.2. This is not the most likely scenario, but it certainly cannot be ruled out at this stage given the possibility of a further escalation of the Eurozone

crisis. At the same time, there are also some upside possibilities, which could see a strong recovery of the economy to a growth rate of around 3% in 2013, although this would be likely to provoke rises in interest rates during the course of next year in order to keep inflation under control in the medium term in this higher growth scenario.

In summary, our main scenario is for modest underlying growth in the UK economy over the next year, but with some prospects for a pick-up during the course of 2013 if downside risks relating to the Eurozone crisis can be successfully navigated.

Outlook for the UK housing market and policy implications

As discussed in detail in Section 3 below, the UK housing market is likely to remain relatively flat in the short term whilst economic uncertainty persists, particularly in relation to the crisis in the Eurozone. But house prices should rise again later in the decade as supply shortages reassert themselves.

Our econometric modelling work suggests that average UK house prices are unlikely to return to 2007 levels in cash terms until the middle of this decade at the earliest, and in real terms not until after 2020, as shown in Figure 1.3. This chart shows our central model projections for both real and nominal house prices as well as a plausible range for the latter taking account of the considerable uncertainties surrounding around any such projections.

Average UK house price (£)

Figure 1.3 – PwC house price projections

Source: PwC; Halifax; Nationwide

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

500,000

Real house prices - central scenario (at 2007 values)Nominal house prices - central scenario (with range shown as shaded area)

2007

Note: Historical series is a simple average of the Halifax and Nationwide indices.

2007 price

’08 ’09 ’10 ’11 ’12 ’13 ’14 ’15 ’16 ’17 ’18 ’19 ’20 ’21 ’22 ’23 ’24 ’25


ment assistance. Policy initiatives would therefore be desirable to support and encourage investment in the private rented sector.

UK vs G7 economic performance and prospects

During the rapid economic expansion of the decade preceding the global financial crisis, the UK economy recorded impressive growth relative to its G7 peer group, as shown in the first set of bars in Figure 1.4. As discussed in more detail in Section 4 of this report, the UK also achieved reductions in unemployment, low and stable inflation, and high growth in labour productivity over this period.

In the long term, however, house prices are likely to stay high relative to earnings by historic standards as the effect of supply shortages outweighs the effect of tighter credit conditions, particularly for first time buyers. Without assistance, a single earner household is unlikely in future to be able to afford to buy their first house until their late 30s.

There is therefore a need for new rental properties as more young people will have to rent for longer in future. Moreover, an increasing number of people will be unable to participate in the private housing market without affordable rental housing or govern-

The recession of 2008-9 saw sharp contractions in output across the G7, but the UK was one of the hardest hit. This was accompanied by UK inflation being the highest in the G7 and its unemployment rate increasing (and although not by as much as in past UK recessions).

Over the recovery period since mid-2009, growth in the UK has remained relatively weak in comparison to the US, Germany, Canada, France and Japan, as Figure 1.4 shows, while UK inflation and (to a lesser degree) unemployment have continued to rise. The UK has reduced its structural budget deficit by more than any other G7

country since 2009, but the wider economic benefits of this have yet to come through.

Medium term growth prospects for the UK should be better, however, with both inflation and unemployment rates expected to fall back over the next few years according to both OBR and IMF projections.

Short-term policy responses are limited due to the UK government’s commitment to deficit reduction and an already accommodative monetary policy, so the priority will be to pursue supply side reforms that boost infrastructure, skills, innovation and efficiency in order to promote long term growth.


Key points

• Recovery in the UK has stalled over the past year as the Eurozone crisis has taken its toll. However, while official data suggests that the economy fell back into a technical recession in the first quarter of 2012, labour market and business survey data suggest continued modest growth. The second quarter may have seen further weakening as the Eurozone crisis flared up again, but hard data on that is patchy at present.

• One positive development has been lower inflation, which we expect to fall back towards its 2% target rate over the next year unless there is a significant resurgence in global commodity prices. This should allow the Bank of England to continue to maintain an accommodative monetary stance.

• The UK business climate map in Figure 2.1 summarises our assessment of the outlook across the country. For the UK as a whole the outlook remains cloudy but with scope for improvement: we see broadly flat GDP in 2012, but picking up in 2013 in our main scenario. London and the South East are projected to lead this gradual recovery, but all regions are projected to see at least modest average growth in 2012 and 2013 taken together (as shown in the map). However, risks from further storms in the Eurozone are still firmly weighted to the downside and businesses should plan accordingly.

Introduction

In this section we describe recent develop-ments in the UK economy and review future prospects. The discussion is organised as follows:

2.1 Recent developments and the present situation

2.2 Economic growth prospects: national, sectoral and regional

2.3 Outlook for inflation

2.4 Fiscal and monetary policy options

2.5 Summary and conclusions

2.1 – Recent developments and the present situation

Recovery in the UK has stalled, but signals have been mixed

Latest estimates from the Office for National Statistics (ONS) show that the UK is now in a technical recession as the economy contracted quarter-on-quarter by 0.4% in Q4 2011 and 0.3% in Q1 2012. These figures are lower than forecasters expected a year ago and seem to contradict other indicators from the labour market and business surveys, which suggest that the economy grew modestly in the first quarter. The ONS figures are often subject to large revisions, so we would not be surprised to see the Q1 growth estimates revised up in future years. This is not guaranteed, however, so our GDP projections in this report are still based on the official data up to Q1 2012.

2 – UK Economic prospects

Figure 2.1 – UK business climate map

UK outlook – cloudy but improving

Scotland

North West

Northern Ireland

North East

Wales

Yorkshire & Humberside

Source: ONS, Eurostat, PwC analysis based on latest data available as of 28 June 2012.Note: Eurozone employment rate is from 2011; figures on employment levels in early 2012 show falling employment.

68.60.5%

67.10.4%

66.50.5%

68.00.5%

68.90.8%

South West

East Midlands

73.20.8%

71.90.8%

South East

West Midlands

74.81.3%

London

East

74.90.7%

70.60.8%

Eurozone – still stormy

64.20.0%

71.10.7%

68.70.8% 67.71.1%

Estimated average GDP growth in 2012 and 2013 / Latest Employment rate

increasing employment rate no change in the employment rate falling employment rate

% change in the year to Q1 2012

Figure 2.2 – Growth in the expenditure components of GDP in both real and nominal terms

Source: ONS

-2

-1

0

1

2

3

4

5

6

7

GDPImportsExportsDomesticdemand

Governmentconsumption

Fixedinvestment

Consumerspending

Real Nominal

-0.9%

2.0% 1.9%

6.0%

3.0%

3.7%

0.3%

2.8%

-1.0%

1.2%0.7%

4.3%

-0.2%

1.8%


Data issues aside, it is clear that the recovery of the UK economy has stumbled as the Eurozone crisis has damaged consumer and business confidence, with these problems flaring up again since April. If we compare the latest real and nominal data for Q1 2012 to the same quarter in 2011 (Figure 2.2), we can see that both consumer spending and exports were lower in Q1 2012 in real terms than a year earlier, although both showed modest growth in nominal terms. Since imports rose modestly in real terms (and more markedly in nominal terms), the contribution of net trade to GDP growth turned negative during this period in contrast to the pattern seen for much of 2011. This adverse recent trend primarily reflects ongoing problems in the Eurozone, which remains by far the UK’s most important export market, even if its share in total UK exports has been declining steadily in recent years while share of UK exports going to much faster growing emerging markets has gone up.

The main factors boosting real GDP growth in the year to Q1 2012 were fixed investment and government consumption – the latter may seem surprising given constraints on cash spending, but the way that the national accounts measures real government consumption is based largely on output measures that are not much affected by these reductions in nominal spending

growth in the short term. Instead the impact is to compress the implied price deflator for government consumption, which as Figure 2.2 shows was estimated at just 0.7% in the year to Q1 2012, well below other economy wide measures of inflation over this period. In reality though what may be happening is that the quality of government services is being eroded by the constraints on cash spending, but this quality effect is hard to measure and may come through only gradually so it is not been captured as a decline in real government output and consumption. To this extent, official measures of GDP may actually be overstated at present due to artificially high real government consump-tion and output growth estimates.

Going forward, a critical factor will be whether real household spending can recover as the severe squeeze on real disposable incomes from high inflation starts to fade over the course of this year and into 2013, so long as there is no renewed sharp rise in global commodity prices over this period. Inflation prospects are discussed further in Section 2.3 below, but will also have an important influence on real growth prospects for this reason.

Retail sales volumes1 have held up reasonably well, growing by 2.4% in the year to May 2012, although these figures have been erratic from month to month. This is often

Index (January 2007 = 100)

US

UK

Eurozone

Figure 2.3 – Equity market indices

40

50

60

70

80

90

100

110

120

Euronext 100 Source: DatastreamFTSE 100 Dow Jones Industrial

the case with retail sales data, particularly in recent months due to the shifting timing of Easter from year to year.

Lower unemployment may also have supported consumer spending to some degree in first four months of this year, although it remains to be seen whether this will continue into May and June given renewed problems in the Eurozone in those months that will have eroded UK consumer confidence to some degree. The flat housing market (at UK average level even if not for more affluent parts of London) is also a dampening influence on consumer spending

growth at present and seems likely to remain relatively subdued some time to come, as discussed in more detail in Section 3 below.

When we look at business investment trends there is some cause for cautious optimism. Despite the fact that that investor confidence is fragile due to the Eurozone crisis, business investment, which accounts for just over 50% of fixed investment (the other major components being investment in house building and government investment, which have been much weaker over the past year), grew by an estimated 14.8% in real terms over the year to the first quarter2.

1 Includes automotive fuel 2 Although this particular year-on-year growth rate is exaggerated by unusually weak business investment in Q1 2011. In 2011 as a whole, real business investment growth was much more modest at just 1.3% relative to 2010 annual average levels. This may be a better guide to underlying trends at present than the Q1 2012 figures.


However, these investment trends have been erratic from quarter to quarter and it is too early to point to a sustained recovery here: although many large companies are sitting on considerable cash piles, most will be reluctant to make major investments until the fog of uncertainty relating to the Eurozone crisis clears (or has been around long enough for companies to get used to it and so be less sensitive to this uncertainty).

The UK has also been viewed as a ‘safe haven’ for investors as the euro crisis has worsened, meaning that capital has flowed into the UK and helped to support asset prices here. By the beginning of 2012, the FTSE 100 was close to pre-crisis levels and has on average performed well over the past 2-3 years compared to the Euronext, whose performance remains only marginally above the depths plumbed at the height of the financial crisis (see Figure 2.3). However, worldwide markets have been spooked by the deepening of the Eurozone crisis in recent months and the FTSE has fallen back (and by rather more than the Dow Jones, as Figure 2.3 shows). So the financial market climate remains volatile and seems likely to remain so for some time to come.

On the supply side of the economy, the production and construction sectors in the UK have suffered the most over the past year, whilst services have shown modest growth (Figure 2.4). Earlier in the year some

survey-based indicators, such as the CIPS/Markit Purchasing Managers’ Index (PMI) of services and manufacturing, suggested a degree of positive momentum across the UK economy. However, poor outturn data and the re-emergence of turmoil in the Eurozone since April after a period of relative calm in the first quarter, have led to fading optimism and activity. The latest data in Figure 2.5 shows that the Manufacturing PMI dropped particularly sharply to 45.9 in May although it then rose back to 48.6 in June. Activity trends remain in positive territory in the much larger services sector, but have slowed in recent months.

Labour market data has brought more positive news, although this may change as the data catches up with the recent deterioration in economic conditions. The UK unemployment rate fell to 8.2% and the employment rate rose to 70.6% in the three months to April. Over the same period, 205,000 extra people were working in the private sector, whilst only 39,000 fewer people were working in the public sector. Over the year to April 2012, the picture was less positive but private sector employment growth still just outpaced public sector losses, meaning that 42,000 more people were in employment in the three months to April compared to the same period last year. This tended to be focused more on self employment and part-time employment, however, rather than full-time employee jobs

% change on a year earlier, Q1 2012

Figure 2.4 – Sectoral output growth

Source: ONS

-6.0

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

ConstructionUtilitiesManufacturingDistribution, hotels& restaurants

Business services& finance

Transport, storage& comms

1.8%

0.9%

0.4%

-1.4%

-2.0%

-4.0%

Index (January 2007 = 100)

Figure 2.5 – Purchasing Managers’ Indices of business activity

30

35

40

45

50

55

60

65

Above 50 indicatesrising activity levels

Manufacturing Source: CIPS/MarkitServices


in itself but could indicate that the recent rally in employment may not be sustained through May and June given the negative shocks to confidence from the Eurozone. At the time of writing, hard data are lacking on this whether from the labour market or other sources, but risks appear to be weighted to the downside in the short term.

2.2 – Economic growth prospects

GDP projected to be broadly flat on average in 2012, but should pick up gradually in 2013

Our main scenario for UK GDP shows zero growth for 2012 as a whole, but this disguises a projected gradual upward trend between the first and second halves of the year that continues into 2013. Estimated real government spending is likely to remain a positive contributor to growth in 2012 (although this is expected to fade in 2013), while real consumer spending growth should be boosted by an expected continued downward trend in consumer price inflation (see Section 2.3 below). Investment should be another positive contributor in 2012-13 (led by business investment given weak government investment). Net exports may be a negative influence on growth in 2012, but should have a modestly positive impact on GDP growth in 2013 (Table 2.1). This assumes a gradual calming down of the Eurozone crisis and stronger UK export growth to non-EU markets.

(though the latter did also pick up in the three months to April after earlier weakness).

Growth in regular pay picked up slightly to 1.8% in the three months to April 2012 relative to the same period a year earlier, but average earnings growth remains below consumer price inflation and very low by historic standards. This helps to keep price inflation down but, less positively, also reflects the continuing nervousness of employers and employees about the future.

The relatively good recent labour market news has been shared fairly evenly around the country. At the regional level, the labour market data for the three months to April 2012 shows that employment increased on the previous year in 8 of the 12 UK regions (see Figure 2.1 above). The North East saw no change in that period, while Northern Ireland, Wales and the South West were the only three regions to see falling employment rates. The South West has been particularly affected by public sector job losses and experienced the largest drop in public sector employment of all the UK regions over the past year.

It should be borne in mind that the good news on UK labour market trends up to April may not last. The timelier, but more narrowly defined, claimant count measure of unemployment shows an increase of 8,000 benefit claimants in May. This was not major news

Source: ONS, PwC

(% real growth unless stated) 2011 2012 2013

GDP 0.7 0.0 1.7

Consumer spending3 -1.1 0.1 1.3

Government consumption 0.1 2.9 0.4

Fixed investment -1.4 2.8 3.6

Domestic demand -0.5 0.6 1.4

Net exports (% of GDP) 1.2 -0.7 0.3

CPI (%: Q4) 4.7 2.4 2.0

Table 2.1 – PwC main scenario for UK economy

Source: Source: ONS, OBR, HM Treasury Survey of Independent Forecasts (June 2012). *Q1 2012 only.

(% real YoY growth unless stated) Actual or Actual or OBR forecasts Average latest latest (March 2012) independent estimates estimates forecast (June 2012)

Table 2.2 – Official and independent forecasts

2011 Q1 2012 2012 2013 2012 2013

GDP 0.8 -0.2 0.8 2.0 0.3 1.7

Manufacturing output 2.1 -1.4 n/a n/a -0.3 1.7

Consumer spending -1.1 -0.9 0.5 1.3 0.6 1.3

Fixed investment -1.4 1.9 -0.3 6.2 0.1 3.7

Government consumption 0.1 3.0 0.5 -1.1 0.5 -0.9

Domestic demand -0.5 0.3 0.3 1.5 0.2 1.3

Exports 4.4 -1.0 2.9 5.3 2.2 4.3

Imports 0.5 0.7 1.4 3.8 1.8 3.0

Current account (£ bn) -29.0 -11.2* -27.0 -21.0 -26.8 -21.7

Unemployment claimant count (Q4 m) 1.60 1.61* 1.65 1.64 1.70 1.71

3 We define this here as household consumption expenditure not including consumption by not-for-profit institutions serving households such as pension funds and life insurance companies.


Our main scenario appears slightly more pessimistic than the average of independent forecasts at the time of writing (as shown in Table 2.2), but this consensus growth projection has been trending down since April and is expected to fall further as forecasters adjust their estimates to allow for the latest official GDP data (this applies even more so to the OBR forecasts made in March). If we look ahead to 2013, however, our main scenario for UK GDP growth of 1.7% is in line with the consensus view and only slightly lower than the OBR’s 2% projection for growth next year.

There is always considerable uncertainty about future growth prospects and even more so at present due to the Eurozone crisis. We reflect this uncertainty in the alternative growth scenarios shown in Figure 2.6. This chart also illustrates well the way that the recovery seen between mid-2009 and Q3 2010 has run out of steam since then.

• The ‘strong recovery’ scenario sees a marked pick-up in the UK economy towards the end of the year on the back of the Olympics, rising to 3% growth in 2013. This assumes that the situation in the Eurozone calms significantly with a rapid return of business and consumer confidence in the UK on the back of this, boosting both consumer spending and investment (as well as the direct positive impact on UK exports to the Eurozone in this scenario).

• The ‘prolonged recession’ scenario sees the UK remaining in recession this year and next as the recent erosion in business and consumer confidence persists on the back of worsening problems in the Eurozone and associated pressures on banks across Europe leading to a widespread shortage of credit. This makes expansion and in some cases continuation of business very difficult, so that insolvencies and unemployment rise and consumers and businesses reduce spending and investment further as confidence spirals down.

Although we do not believe that these alternative scenarios are the most likely outcomes, businesses should be stress testing against the ‘prolonged recession’ scenario in particular given that this has severe potential implications for the prospects of a wide range of UK companies with direct or indirect exposure to the Eurozone4.

Outlook for major industry sectors

Our main scenario shows growth being led by the service sectors in 2012, but with the manufacturing and construction sectors making more of a contribution in 2013 (Figure 2.7). Predicting sectoral growth is very difficult, so there is wide uncertainty around these main scenario projections, but the underlying rationale behind them is that, whilst demand in our key EU export markets is likely to remain relatively weak in 2012-13, the manufacturing sector should achieve a gradual reorientation towards non-EU markets over time.

Projected % real output growth

Figure 2.7 – Sectoral output (GVA) growth in main scenario

Source: PwC main scenario

-5

-4

-3

-2

-1

0

1

2

3

ConstructionManufacturingGDPDistribution, hotels& restaurants

UtilitiesBusiness services& finance

Government& other

Transport, storage& comms

2012 2013

1.3%

1.9%

0.8%0.6% 0.6%

2.4%

0.3%

1.6%

0.2%

1.6%

0.0%

1.7%

-1.0%

2.3%

-4.2%

2.0%

Projected % change on a year earlier

Figure 2.6 – Alternative GDP growth scenarios

-8

-6

-4

-2

0

2

4

Main Source: ONS, PwCStrong recoveryProlonged recession

Scenarios

4 See the material on our website for more details on how businesses can navigate uncertainty in the Eurozone: http://www.pwc.co.uk/economic-services/publications/navigating-uncertainty-in-the-eurozone-the-future-of-the-eurozone-and-its-impact-on-your-business.jhtml


Producer input price inflation, which measures the change in the price of materials and fuels purchased for the manufacturing process, has been higher than producer output price inflation since late 2010, but that gap is now falling (see Figure 2.9). This is largely due to recent declines in global oil prices in response to weaker global growth trends and short term prospects, although there is always a risk that this could go into reverse at some point.

Our main scenario shows consumer price inflation (CPI), which is currently 2.8%, falling gradually through the rest of 2012 and 2013, reaching the Bank of England’s CPI target of 2% later next year. This reflects falls in commodity prices feeding through, demand remaining weak and earnings growth relatively subdued. To reflect the upside and downside risks to the main scenarios we also present two plausible alternatives (Figure 2.10):

• In the ‘higher inflation’ scenario a combination of stronger than expected demand and increases in global commodity prices pushes inflation back up to above 3% next year.

• In the ‘lower inflation’ scenario demand in the UK is much weaker than expected, and the situation in the Eurozone causes the pound to appreciate relative to the euro, leaving inflation falling towards 1% by the end of 2013.

The service sectors generally have a higher long-term growth trend and are less sensitive to short term cyclical downturns in the international economy and so hold up better in 2012 but do less well in relative terms in 2013 in our main scenario (though they would be less exposed to the prolonged recession scenario than the more cyclical manufacturing and construction sectors).

Outlook for the regions

The outlook for the regions is strongly affected by their varying sectoral mixes. In 2012, those regions with a stronger presence of production industries are projected to do somewhat less well, but this effect is less pronounced in 2013, when all regions are projected to see some recovery in output as shown in Figure 2.8. However, in both 2012 and 2013 the variation in regional performance is relatively small, with the dominant factor for all regions being the national economic growth trend. It should be borne in mind here that, for most regions, we do not have any actual output (GVA) data beyond 2010, so any such projections are subject to wide margins of uncertainty even as to recent trends, let alone future growth.

2.3 – Outlook for inflation

Inflation is projected to continue falling, which should ease the squeeze on consumers

Projected % real growth

Figure 2.8 – Regional output (GVA) growth in main scenario

2012 2013 Source: PwC

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

NorthernIreland

NorthNorth WestWalesEast AngliaScotlandEastMidlands

WestMidlands

Yorkshire& Humber

South WestGreaterLondon

South East

0.4%

2.2%

0.4%

1.8%

-0.1%

1.7%

-0.2%

1.7%

-0.2%

1.7%

-0.2%

1.7%

-0.2%

1.5%

-0.2%

1.6%

-0.3%

1.4%

-0.3%

1.4%

-0.4%

1.3%

-0.4%

1.1%

Index (2010 = 100)

Figure 2.9 – Producer price inflation

70

80

90

100

110

120

130

Input prices Source: ONSOutput prices


although they are a contingent liability that could add to debt should the loans go bad. Nonetheless it does make sense for the government to do what it can to support private investment in this and similar ways at a time of depressed confidence and bank funding problems.

On the monetary policy side, the Bank of England is likely to keep base rates on hold for the foreseeable future as inflation is falling and the growth outlook remains weak. The Monetary Policy Committee (MPC) could also consider further quantitative easing if growth deteriorates further in response to additional adverse Eurozone shocks, though this may run into diminishing returns. As announced last month, action to boost bank liquidity and support bank lending could also be helpful, though they are more about limiting the downside for the economy than being likely to promote strong growth in the short term. Medium term supply side reforms, as outlined in the article by Andrew Sentance in the previous issue of UK Economic Outlook, should remain the priority going forward.

2.4 – Fiscal and monetary policy options

With the outlook for growth weakening in recent months, pressure for policy action has been mounting. On the fiscal side, we can see from Figure 2.11 that the budget deficit has been declining gradually over the past two years, but the debt stock to GDP ratio is still rising and there is little room for manoeuvre. The latest data for April and May 2012 show that the underlying budget deficit (excluding distortions related to the transfer of Royal Mail pensions to the government) was somewhat higher than expected, reflecting in particular the dampening effect on tax receipts of weaker growth.

This situation makes it difficult for the government to loosen fiscal policy to any significant degree without unsettling the bond markets, although there may be some steps that could be taken to re-orient spending towards, in particular, productive infrastructure investment. The government has already announced that it will start to guarantee loans to businesses in order to encourage investment. These guarantees do not affect the balance sheet directly,

Net debt as a % of GDP (year end)

Figure 2.11 – Public sector finances

0

10

20

30

40

50

60

70

2011/122010/112009/102008/092007/082006/072005/062004/052003/042002/032001/022000/01

Source: ONSBudget deficitNet debt

-6

-4

-2

0

2

4

6

8

10

12

14Budget deficit as a % of GDP

31% 30% 31% 32%34% 35% 36% 37%

44%

53%

61%

66%

% change on a year earlier

Figure 2.10 – Alternative inflation (CPI) scenarios

0

1

2

3

4

5

6

Main Source: ONS, PwCLow inflation High inflation

Scenarios

MPC target (2%)


2.5 – Summary and conclusions

The recovery in the UK has stalled over the past year as the ongoing Eurozone crisis has weakened business and consumer confidence. In the first four months of 2012 there were some positive signals from both the business surveys and labour market data, although conditions in the Eurozone have deteriorated significantly since April and it seems likely that growth will be negative in the first half of 2012 as a whole.

In our main scenario, UK growth picks up gradually through the rest of 2012 and into 2013. The Olympics are likely to provide a short term boost in Q3 2012, but the more

important factor is declining inflation, which should ease the pressure on consumers as well as allowing more flexibility for the Bank of England to continue to pursue a highly accommodative monetary policy. Net exports are likely to make more of a contribution to growth in 2013 than in 2012, while business investment should be a positive factor in both years.

The short term risks are still weighted to the downside as the situation in the Eurozone remains precarious. Further turmoil could see credit conditions worsen and demand shrinking sharply. UK businesses should therefore be stress testing against these

kinds of downside scenarios and making appropriate contingency plans. On the other hand, many larger businesses are sitting on significant cash piles that could lead to a large boost to investment as and when current uncertainty about the Eurozone eases, or at least comes to be seen as a normal aspect of the economic situation that businesses have to live with.

Overall, the road to economic recovery in the UK is likely to remain bumpy, but we are still cautiously optimistic that, after a broadly flat year in 2012 as a whole, growth should return to positive territory in 2013.


3 – The UK housing market: What’s coming next and what does it mean?

Key points

• The UK housing market is likely to remain relatively flat in the short-term whilst economic uncertainty persists. The crisis in the Eurozone remains a key downside risk in the short- to medium-term and further deterioration of the situation could lead to double digit declines in house prices over the next couple of years.

• Nominal house prices are unlikely to return to 2007 levels until the middle of this decade, and in real terms not until the mid 2020s. In the long term house price growth is likely to be far more modest than prior to the financial crisis, although the ratio of house prices relative to earnings is expected to remain at very high levels by historical standards.

• In the long-term the house price to earnings ratio is likely to remain high, as the effect of housing supply shortages outweighs the effect of tighter credit conditions, particularly for first time buyers. Without assistance, a single person is unlikely to be able to afford to buy their first house until their late 30s.

• There is an urgent need for new rental properties as young people will, in all probability, have to rent for longer. Moreover, an increasing number of people are likely to be unable to participate in the private housing market without affordable rental housing or government assistance. Policy is needed to support and encourage investment in houses for rental.

Introduction

It is our view that the housing market is in a period of transition and is likely to recover to its “new normal” in the medium term, once the wider economic recovery picks up steam. The new normal for the housing market is likely to see more modest growth in prices, but increasing difficulties for young people wanting to get onto the housing ladder. This brings challenges and opportunities for business and policy makers (see Table 3.1).

Structure of this article

This article first discusses the outlook for house prices and our projections for house prices in the short and medium term. It then sets out the key features of the “new normal” in the post-financial crisis housing market, including more restricted access to finance for first-time buyers and pressures on housing supply. We conclude with some policy implications - particularly focussing on the rental market.

3.1 – Recent developments in the housing market

Since the housing bubble burst in 2007, UK house prices have fallen by 18% (to Q1 2012). After an initial bounce-back in 2010, house price growth slowed and reversed again in 2011. Recent months have seen a broadly flat housing market with prices in June 2012 down by 0.5% on June 2011, but up by 1% on May 2012, according to the Halifax index (Figure 3.1). The Nationwide

Challenges Opportunities

Low levels of activity in the housing market • Preparing for medium-term growth opportunities.

Ensuring enough houses are built in the right • Strategic investment in areas of high places to satisfy demand demand for housing • Using momentum behind planning reform to enable the housing to stock to respond to market signals.

Restricted access to credit particularly for • Increasing demand for products that first time buyers provide equity finance for house purchase.

Coping with increasing demand for • Policy to make investment in rental affordable rental properties properties a more attractive prospect • Using large scale regeneration schemes as an opportunity for investment in rental housing

Inter- and intra-generational inequality • Expanding shared equity type models to enable those without wealthy relatives to get onto the housing ladder • Using housing wealth to address the fiscal sustainability problems which will result from an aging population and to respond to the challenge of funding long-term care posed by the Dilnot review1

1 http://www.dilnotcommission.dh.gov.uk/our-report/ 2 http://www.pwc.co.uk/the-economy/publications/research-archive-uk-economic-outlook.jhtml

Table 3.1 - Challenges and opportunities relating to the housing market

demand and high prices, the East, South East and London, have experienced the smallest declines in prices (Figure 3.3). Our work on regional financial stress (UKEO November 20112) showed that those regions also experienced the least relative financial stress during the recession. On the other hand, Northern Ireland clearly had the worst relative experience of all in this period.

index shows prices down by 1.5% in June on the previous year and down 0.6% on May. Transaction volumes remain well below their pre-recession peak, with the number of transactions down by 18% in April on March, but up by 2.9% on last year (Figure 3.2).

Regional differences in the housing market persist. The areas of traditionally high


% change on a year earlier

Figure 3.1 – Year on year growth in house prices

Source: Nationwide, Halifax

’95 ’96 ’97 ’98 ’99 ’00 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09 ’10 ’11 ’12-20

-10

0

10

20

30

40

Nationwide index Halifax index

000s

Figure 3.2 – Residential property transactions valued over £40,000

2006 2007 2008 2009 2010 2011 2012Source: Council of mortgage Lenders; HMRC

0

20

40

60

80

100

120

140

160

The significant decline in house prices seen in Northern Ireland followed the biggest housing boom of all the regions. This resulted from years of previous under-development and easy credit spilling over from the neighbouring Republic of Ireland, which itself experienced a large housing bubble. Whilst the remainder of this article does not deal with the outlook at regional level, it is important to keep in mind that the analysis presented below may apply differently to the different regions.

3.2 – The outlook for UK house prices

In the short term the dominant influence on the housing market is likely to be the weak and uncertain economic outlook (see section 2 for our views on the outlook for the wider economy). Our central scenario for house prices shows a modest decline in growth this year picking up into 2013 (Figure 3.4). Buyers are likely to remain deterred by uncertainty about their employment and earnings prospects and by the fear of continuing falls in prices. Lending institutions are under pressure to repair balance sheets and are likely to remain averse to taking on risky prospects, and as a result obtaining mortgage credit will be difficult for many households. Countering the downward pressure on prices is a shortage of properties for sale. House owners are exhibiting loss aversion (a phenomenon originally documented by Kahneman and Tversky in the 1970s3) – that is, they do not want to

bring their houses to market and realise losses. This is likely to continue to prevent house prices from falling further than they would have otherwise.

The key risk to this will be developments in the Eurozone. The turmoil caused by a disorderly exit of one or more countries from the Eurozone leading to a credit crunch could see double digit declines in prices as the supply of credit dries up and banks are obliged to force the owners of an increasing number of distressed mortgages to sell their properties. We consider the risk of a severe credit crunch small but not insignificant and those with property in their portfolio should be stress testing against this risk.

Our projections for house prices are based on our own econometric model. Projecting house prices is an extremely difficult business with large uncertainties and we reflect this by showing a probability fan around our central scenario, generated using a Monte-Carlo analysis. This analysis allows the input variables to vary at random (but restricted to a plausible range) to account for all the uncertainties there are associated with the central value. The results of the model are calculated thousands of times with the differing random values. The fan on the chart shows the range within which 90% of the results fall, suggesting that there is only a 10% chance that house prices will be outside that range. For further technical

3 Kahneman, D. & Tversky, A. (1979). Prospect Theory: An Analysis of Decision under Risk. Econometrica 47, 263-291


% change

Figure 3.3 – Change in house prices between Q4 2007 and Q1 2012

Source: Halifax

-60

-50

-40

-30

-20

-10

0

NorthernIreland

ScotlandNorthWalesNorth WestWestMidlands

UKYorks andHumb

EastMidlands

SouthWest

SouthEast

GreaterLondon

East Anglia

Note: According to the Nationwide index, peak house prices were in Q4 2007

Average UK house price (£)

Figure 3.4 – PwC house price projections

Source: PwC; Halifax; Nationwide

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

500,000

Real house prices - central scenario (at 2007 values)Nominal house prices - central scenario (with range shown as shaded area)

2007

Note: Historical series is a simple average of the Halifax and Nationwide indices.

2007 price

’08 ’09 ’10 ’11 ’12 ’13 ’14 ’15 ’16 ’17 ’18 ’19 ’20 ’21 ’22 ’23 ’24 ’25

details of the modelling please refer to the appendix of this paper.

Our central estimate for house prices in the short term sits within the range of independent forecasts (see Table 3.2), although given the uncertainty of the current economic climate that range is wide. Our overall range is much wider as the independent forecasts only summarize central projections and our range includes downside and upside possibilities. Box 3.1 summarises what other commentators are saying about house prices, and it can be seen that our analysis does not differ wildly from their views, although our prognosis is somewhat more optimistic than that of Capital Economics.

As the economic recovery gathers momentum and optimism returns in the medium-term, those with access to finance should feel confident enough to take the opportunity of purchasing houses when prices are at or near the bottom of the cycle. Supply constraints

are likely to kick-in because house building has almost ground to a halt during the recession and low interest rates and the willingness of lenders to restructure payments has meant the pressure on owners to sell is weak. These supply constraints are likely to be exacerbated by the loss aversion effect described above which could persist as, in cash terms, prices are unlikely to reach 2007 levels until the mid-2010s and in real terms not until the early 2020s. This is likely to boost growth in prices in the medium-term, although, tighter credit conditions than prior to the recession are likely to keep that growth in check.

Long run house prices are closely linked to income growth. The explanation is simple – if house prices continually grew faster than income then fewer and fewer people would be able to buy them. As demand fell, prices would be forced down too. If this is true then there is a long run-equilibrium value for

Treasury independent forecasts PwC Projections Outturn Average Range Central Range 90% of outcomes)

2011 -1.40%

2012 -1.6% -4% - +1.5% -1.3% -18.3% - +15.4%

2013 -0.2% -5.3% - +3.4% +0.6% -14.9% - +12.2%

Long run average +4.6% +0.7% - +6.8%

Table 3.2 – Comparison of independent and PwC forecasts for nominal annual house price growth

Source: HM Treasury, PwC analysis


the ratio of house prices and earnings. That value should guide the long-run projections of house prices. However, determining the position of that equilibrium is not straightforward.

Over time the ratio of house prices to earnings has fluctuated considerably. In the period leading up to 2007 that ratio grew to over six times average annual earnings (see Figure 3.5). That level was clearly unsustainable. The experience from past bubbles suggests that the house price -to- earnings ratio falls considerably after a bust. Given that the decline in the ratio since 2007 has been modest by historical standards, and the ratio is still well above the peak reached in the bubble of the late 1980s, this might imply that the ratio has a lot further to fall.

However, looking at past patterns does not really give the full picture. In reality there is unlikely to be a long-run stationary average because, as incomes grow, individuals are able to spend more on housing because necessities such as food and travel consume a smaller proportion of income. In addition, international investors can buy UK housing, providing an extra source of demand for housing. Foreign ownership of housing is particularly prevalent in London, but its effect on house prices can ripple out to the rest of the country, although further research needs to be done to quantify its effect.

In our central scenario, prices and earnings stabilise at around 5.4 times earnings although growth in long-run house prices runs slightly ahead of earnings growth into the mid-2020s. It is important to note that there is considerable uncertainty around those values. The main driver of the sustained high price-to-earnings ratio is an ongoing shortage in housing supply. Changes in policy which ameliorated those constraints could lead to a price-to-earnings ratio closer to historical levels.

3.3 – Financing a house purchase with debt is becoming more difficult and costly

Since the onset of the crisis mortgage lending has dropped sharply; this is partly due to weak demand fuelled by uncertainty about the future, but also because credit has become more difficult to obtain.

In the period leading up to the recent crisis the extent and ease of access to mortgage credit was unsustainable. As David Miles of the Monetary Policy Committee noted in a speech4 last year, mortgage costs in the early and mid-2000s almost certainly did not reflect the risks associated with the lending. Figure 3.6 shows that mortgages with 95% loan-to-value ratios and those with 75% were charged at almost identical interest rates, despite carrying very different risk profiles.

4 Miles, David. Mortgages and housing in the near and long term. Speech at the Home Builders Federation Policy Conference, London, 31 March 2011

“We expect this situation to continue with prices likely to still be around today’s levels at the end of 2012 as the ongoing tough economic environment constrains housing demand.” i

Martin Ellis, Housing economist, Lloyds Banking Group, 07 June 2012

“Demand for homes remains subdued on the back of weak labour market conditions, but the lack of homes coming onto the market is providing support for prices” ii

Robert Gardner, Nationwide’s Chief Economist, May 2012

“Falling economic output, rising unemployment and fragile consumer confidence will all do their bit to undermine house prices this year. But while housing is still overvalued, low interest rates and widespread lender forbearance mean that a long, gradual decline is more likely than a slump” iii

Capital Economics, April 2012

“ongoing economic instability in the UK and overseas has continued to undermine consumer confidence, and the reluctance of many banks to offer affordable mortgage products has created something of a stagnant market (…) in spite of this, a gradual stability is returning to the market” iv

Peter Bolton King, Royal Institution of Chartered Surveyors, Spokesman, June 2012

Box 3.1 - What other commentators are saying about about the outlook for house prices

i http://www.lloydsbankinggroup.com/media1/press_releases/2012_press_release_brands/halifax/0606_HPI.asp ii http://www.nationwide.co.uk/hpi/historical/May_2012.pdf iii http://www.capitaleconomics.com/uk-housing-market/the-uk-housing-market-analyst/another-difficult-year- for-the-housing-market.html iv http://www.sharecast.com/cgi-bin/sharecast/story.cgi?story_id=20155636


Ratio

Figure 3.5 – House price-to-average earnings ratio

0

1

2

3

4

5

6

7

’75 ’77 ’79 ’81 ’83 ’85 ’87 ’91 ’95 ’97 ’99 ’01 ’03 ’05 ’07 ’09 ’11 ’13 ’15 ’17’93’89Source: Halifax, Nationwide, ASHE

CentralForecast

’19 ’21 ’23 ’25

% interest

Figure 3.6 – Mortgage interest rates by LTV ratio

0

1

2

3

4

5

6

7

8

’75 ’77 ’79 ’81 ’83 ’85 ’87 ’91 ’95 ’97 ’99 ’01 ’03 ’05 ’07 ’09 ’11 ’13 ’15 ’17’93’89Source: Bank of England

’19 ’21 ’23 ’25

Note: Series breaks are owning to lack of products offered.75% LTV90% LTV 95% LTV

%

Figure 3.7 – % of Mortgages offered by interest rate spread over base rate

0

10

20

30

40

50

60

70

80

90

100

2007 2008 2009 2010 2011

>=3% to <4%

Source: Council of Mortgage Lenders, FSA

>4% >=2% to <3% under 2%

Annual growth in dwellings per capita (%)

Figure 3.8 – Real house price growth against housing supply growth in the previous year

-15 -10 -5 0 5 10 15 20-0.4

-0.2

-0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

Source: CLG, PwC calculationsNote: The same pattern appears when supply lagged by 2 years is used.Annual growth in house prices (%)


Jobs per dwelling

Figure 3.9 – Average house prices against jobs per dwelling (Local Authorities 2010)

0 200000 400000 600000 800000 1000000 1200000 1400000 16000000

1

2

3

4

5

6

7

Source: CLG, NomisAverage house price (£)

Net additional stock

Figure 3.10 – House prices (2010 Q1) against additional housing stock (2011-10)

0 200000 400000 600000 800000 1000000 1200000 1400000-500

0

500

1000

1500

2000

2500

Source: CLGAverage house price (£)

Local Authorities in England

In future, mortgage lending is likely better to reflect risk and the need of lenders to hold higher amounts of capital in reserve; that means fewer high loan-to–value mortgages and higher interest rates on all mortgages. Since the onset of the crisis, the overall spread between the banks’ base rates and mortgage rates has widened, and this is likely to persist. Figure 3.7 shows the dramatic change in the wake of the crisis, from a situation in which most mortgage interest rates were predominantly less than 2 percentage points above base rate to the current situation in which nearly 50% of mortgage lending is at rates 3ppts or more above the base rate. The average spread over the base rate is now falling slowly, but will most likely not fall to anywhere near pre-crisis levels, as tougher capital requirements for banks and greater emphasis on risk manage-ment are likely to require higher spreads.

In absolute terms rates are likely to stay low whilst the economy remains weak – good news for those who already own mortgages - although in the long-term we expect the Bank of England base rate to rise to around 5%, similar to its pre-recession level. Combined with a larger spread, the cost of mortgage borrowing is likely to be higher in the future than it was prior to the recession.

3.4 – A shortage of housing is keeping prices high

A shortage of houses is keeping prices high and is likely to continue to do so despite difficulties with accessing finance.

At a national level it is difficult to detect the impact of constraints in housing supply on prices. Figure 3.8 plots annual real house price growth against the supply growth in the previous year. We would expect the trend line to be downward sloping to show prices falling where supply has increased. The flat trend line suggests there is no relationship between supply growth and prices.

One explanation of this is that people adjust household size depending on the availability of housing and over time the average size of a household has fallen, so any increase in supply is cancelled out by an expansion in the number of households. However, given the clear preference of people to live in increasingly small households, a shortage of supply should push up prices at the margin.

A second explanation is that increases in the supply of housing have simply not been big enough to counteract the other forces driving house prices upward. Supporting this explanation in our modelling, we find, once we control for rising earnings and credit conditions, that increasing supply does tend to reduce the growth in house prices.

The third explanation is that houses are not built where they are we needed to meet demand. Local authority level data shows a positive correlation between the number of jobs per dwelling and house prices (Figure 3.9), suggesting that supply constraints do push up prices at a local level. At a UK level supply increases don’t show up in prices as

they tend not to affect the areas with the highest prices, meaning there is little impact on the average price. Figure 3.10 supports this hypothesis. It shows that there is little relationship between house prices and subsequent house building. If housing supply was properly responding to market signals we would see a strongly upward sloping line.

The growth in the housing stock is likely to have a strong impact on house prices in the future. If the stock fails to respond to demand the result is likely to be sustained high prices. The current trends in housing stock do not provide encouragement that supply will expand significantly in the short-term. The growth in housing stock per person has been falling since the 1970s and is now negative (Figure 3.11). Since the beginning of the recession house building has ground to a halt, and when the economy starts to recover in earnest this constraint may start to bind. Part of the reason for this slowdown has been the withdrawal of Government subsidies for affordable housing (they have been reduced by 63% since the beginning of this parliament).

In our modelling we have allowed for a return to solid supply growth in the long-term, our rationale being that going through a difficult process to build houses is likely to become increasingly attractive as prices grow and that policy makers will come under increasing pressure to facilitate further additions to the stock. Direct government

intervention (through increased subsidies) is also likely to be required to increase stock at the lower end (of quality and hence more affordable housing). This is because the expected returns can be so low relative to higher quality housing that building afford-able houses is not commercially attractive even when demand is high. Given the cuts to housing benefit, investment in affordable housing looks an increasingly unattractive prospect absent government support.

In the medium term, supply constraints are likely to caused localised problems once economic recovery gets underway. The UK has a scarcity of land available for building. Moreover, planning policy can be restrictive and is frequently victim to ‘Nimbyism’. There are moves underway to reform the planning system, however the impact of proposals is unclear and many within the housing industry fear they are not bold enough.

For investors, housing in areas of high and growing economic activity are likely to be the most lucrative as constraints are likely to take time to work out. For business and policy makers these supply constraints are problematic. For business, high house prices mean that workers require greater compensation or simply cannot afford to live in an area. It may even become more cost-effective to locate elsewhere. For policy makers, the impact on economic activity of a lack of housing is a concern, but so


%

Figure 3.11 – Annual growth in dwellings per person

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

’75 ’79 ’83 ’87 ’91 ’95 ’99 ’03 ’07Source: ONS, PwC calculations

Age

Figure 3.12 – Age of first house purchase

20

25

30

35

40

45

50

5% 10% 15% 20% 25%

Couple buying together today

Source: PwC calculations

Deposit requiredSingle buyer today

Single buyer at height of 80s boom


is the social impact. This manifests itself through thwarted aspiration - owning a house is perceived as an important aspect of wellbeing as detailed in our recent work on “Good Growth”5 – but also through the increasing demands government is likely to be under to provide housing for those who cannot afford to participate in the owner-occupied housing market.

3.5 – Young people are having to wait longer to buy houses

Funding a house purchase through debt has already become more difficult given the need for a larger deposit and because house prices to earnings ratios are high. This trend is likely to continue and will mean that the average age of a first-time buyer is likely to increase and as a consequence young people are likely to spend longer renting and saving.

Given that 95% and 90% loan-to-value mortgages are likely to be rare in future, ownership is likely to only really become realistic in a young person’s 30s. Figure 3.12 shows a stylized calculation of the age at which young people would be able to buy their first house, given the size of the deposit they have to raise. The houses they buy correspond to average house prices for first time buyers in Halifax data, although they grow in line with the long-term assumption in our modelling. All scenarios assume every individual starts saving at age 22 and saves 5% of their gross income towards their

house each year. We assume people earn the median wage for their age (according to ASHE statistics) and each year wages grow in real terms plus a premium for each year of experience. We can see that the availability of mortgages with 5% and 10% deposit requirement makes ownership before 30 a realistic option. Those products are unlikely to be available to first-time buyers in the future. This means the mid-to -late 30s will likely become more normal for a first house purchase for a single person and late 20s early thirties for couples.

These calculations are based on generous assumptions about savings rates, and individuals who cannot consistently save from age 22, or have lower incomes, will not be able to purchase a house until much later. The reality is that many young households save nothing like 5% of their income: the ONS family spending survey reveals that households headed by people under 30 years old saved on average £4.30 a week in 2008 not including pensions and lifesavings. By our calculations that is equivalent to around 1.2% of median income at age 22. Even with 2 people combining resources, owning a house whilst saving at that rate becomes completely unrealistic without high loan-to-value mortgages available.

This analysis jars with the aspirations and expectations of young people. Recent research from the Council of Mortgage

5 http://www.pwc.co.uk/government-public-sector/publications/good-growth-index-our-report-on-economic-wellbeing.jhtml 6 Council of Mortgage Lenders. Maturing attitudes to home-ownership. CML Housing Finance Issue 02 2012 7 Buyers who could not have realistically financed the deposit from their own savings. 8 Council of Mortgage Lenders. Problems for first-time buyers: News and Views no 3. 15 February 2011 9 http://www.jrf.org.uk/sites/files/jrf/2297.pdf

Lenders6 found that around 80% of 18-24 year olds would prefer to own a house in 10 years time. For most, they simply will not save enough to meet their aspirations. To do so young people will have to find ways of securing equity funding from sources other than their own savings.

Relatives are one option, although this model of housing finance has serious problems from an equity point of view – a world which requires parental transfers for a house purchase translates wealth inequality down generations. It also presents a clear obstacle to the government’s objective of increasing social mobility. However, perhaps worryingly, it rapidly seems to be becoming the norm. Research by the Council of Mortgage Lenders suggested that the proportion of first time buyers aged less than 30 and receiving financial assistance from relatives or friends7 more than doubled from 38% to 84% between 2005 and 20108. Help from family is also believed to have contributed to the stabilisation of the average age of first-time ownership, despite the rising price-to-earnings ratio.

The second option is to participate in schemes where equity as well as debt is provided by the financing institution or developer. At present these solutions are used by a limited group of people – often only those below a threshold income are eligible. This model of finance is already used to fund social

housing, but it usually requires government intervention to bear the risks and make it a profitable investment for a private housing association. To roll out such a scheme widely beyond the social sector a way of making it a good investment needs to be established, and this may require government intervention.

Another problem with this model is that shared ownership is not always a stepping stone to moving on in the property market for private participants. This is because owners have to make enough profit on their share of the house to finance the deposit on a whole new house. If their income does not rise or they do not want to downsize then this becomes very difficult9. Shared equity models that enable movement up the housing chain have significant potential, but work needs to go into establishing arrangements for such a scheme that make it beneficial for both parties.

A third option is jointly financing a property with a partner or friend. Having more than one income makes financing a property easier and many people do buy with partners. However where people buy with people other than their spouse or partner, there is a need for a contract to enable termination of the arrangement which increases the complexity and cost. The standardisation of such arrangements and the promotion of it as a norm could encourage more people to explore this route.

3.6 – We need a stronger supply of long-term rental property

The fact is that despite the availability of different ways of funding house purchase, young people are most likely going to rent property for a longer period of time in the future. Figure 3.13 demonstrates that pressures on rented housing, both private and social, are already increasing.

Unlike in some of its European neighbours, the private rental market in the UK is very underdeveloped. The private rental market is dominated by small private landlords who invest in a rental property in order to benefit from the capital gains, rather than institutional investors who invest to realise an income stream. This presents a problem because small landlords generally have little desire or resources to expand and incentives to invest in the quality of the housing are limited. A highly fragmented amateur rental market also renders regulating quality and sharing information with potential renters more difficult.

One answer is to increase institutional investment in rental properties, from pension funds and insurance companies for example. However, there are some significant barriers deterring their involvement. A report in 2008 by the Greater London Authority10 detailed some of those barriers and indicated a clear need for market development. This is likely to require policy action but also provides opportunities for willing entrepreneurs able to take advantage of the opportunity.

Some of the key areas for development are:

• De-risking the income stream from housing: Residential contracts are short, and for institutional investors this means uncertain and limited returns. A possible model might be where another body such as the government backs rental income, or where the investor has a long lease to a registered landlord. This model has been applied in the student housing sector as universities take on some of the income risk to developers.

• Creating a separate class of rental properties: The opportunity cost of holding onto a rental property is high as its value is determined by the owner-occupied market and not by the income it is likely to produce. By creating a separate rental-only property class through the planning system, the impact of high prices in the owner occupied market could be removed, making investing to rent look more attractive. This would have to be carefully managed to ensure flexibility where the relative need for owner-occupied and rental housing changed.

• Generating a stock large enough to realise economies of scale: The stock of rental property is currently small and fragmented, which prevents realisation of economies of scale in management. Large regeneration schemes could provide sufficient scale in the future, provided that policy makers and developers were committed to development of the rental market.


%

Figure 3.13 – % of households living in over-occupied housing

Source: DCLG Survey of English Housing

0

1

2

3

4

5

6

7

8

TotalPrivate rentersSocial rentersOwner occupiers

2001-04 2007-10Note: Overcrowded is one or more bedrooms below the “bedroom standard”

%

Figure 3.14 – % of households in under-occupied housing

0

10

20

30

40

50

60

TotalPrivate rentersSocial rentersOwner occupiers

2001-04 2007-10 Source: DCLG Survey of English HousingNote: Under-occupied ie two or more bedrooms above the “bedroom standard”

10 http://www.bpf.org.uk/en/files/reita/reita_org_documents/reita_UK_GLA_savilles.pdf


3.7 – Incentives to use the space that exists more effectively could help mitigate the shortage of housing

Rates of under-occupation and over-crowding of housing have generally risen over time (Figures 3.13 & 3.14). Although there is a divide between those who can afford to own houses and those who cannot: increases in over-crowding have come in the private and social rented sectors, whilst increases in under-occupation have come in the owner occupied sector. The highest rates of under-occupation are among couples who do not live with children. A typical story is that of a family home which was needed whilst the children were growing up and becomes too large once they have left, but the couple do not downsize because of the emotional and financial costs of moving.

The tax system does not provide clear incentives to dispose of empty space in houses. Firstly, the council tax system makes a dispen- sation for those who live alone and is based simply on property valuation rather than available space. Secondly, many house owners have realised large gains simply from owning the house without needing to rent space and whilst revenue from private rental is taxed as income, wealth accumulated from owning a house is either tax free (if it is associated with the primary residence) or taxed at the lower capital gains rate.

A tax system which rewarded proper use of space, encouraging individuals either to

downsize or to rent out surplus space could go some way to relieving supply pressures. The Rent a Room11 scheme implemented by the Government is a step in the right direction. It allows homeowners to receive £4,250 a year tax free for having a lodger, although the scheme does not cover renting out a whole house or a property that has been converted into flats. A more compre-hensive scheme is likely to be required to achieve improvements in the use of space that really made a difference.

3.8 – Houses will remain a major source of household wealth - there is likely to be increasing demand to unlock it

Figure 3.15 shows that housing constitutes a large proportion of household wealth in the UK. It is likely to remain that way. As housing becomes more difficult to finance, existing house owners get older and increasing life expectancy reduces the churn in the housing market, housing wealth is likely to be increasingly concentrated in the hands of older generations.

There is likely to be an increasing demand for ways of unlocking that housing wealth. The pressure an aging population will put on the already fragile public finances will likely mean that provision of services for older generations will not meet their aspirations or expectations. With pensions also likely to be less generous the demand for products

which allow older generations to release equity from their houses will likely increase. This presents a clear opportunity to those able to supply such products as the market for equity release type products is potentially significant with over-60s in the UK estimated to hold 80% of Britain’s wealth and £1 trillion in un-mortgaged equity12.

The government is already exploring solutions including equity release from housing for funding of long term care of the elderly. Whilst the young will have to bear some of the burden in terms of increased taxes, in a world which cannot rely on easy credit to fund consumption, the pressure is likely to be on to ensure the tax system in the UK remains competitive and attractive for individuals and businesses that can drive

growth. Moreover, any increases in taxes may be checked by a sense of injustice among the young that they are paying in some cases for benefits they are unlikely to receive themselves (e.g. direct benefit pensions)13.

Given the significant amounts of wealth stored in housing in the UK, unlocking it seems an obvious solution although there are some disadvantages. In our response to the Dilnot review into funding tomorrow’s care14 we outlined how housing equity could be used to fund care and indicated some of the advantages and disadvantages of this sort of model. It is important to note that any scheme which did require older generations to use accumulated housing wealth would have to be designed carefully to ensure equity within the older house-owning group.

11 http://www.hmrc.gov.uk/individuals/tmarent-a-room-scheme.shtml 12 Reform. Paying for long term care’. 15 February 2011 13 Although it is also true that the real incomes and variety of goods available is much greater today, so in that sense younger generations will have more than their forebears. 14 http://www.pwc.co.uk/government-public-sector/publications/funding-tomorrows-care.jhtml

% of household income

Figure 3.15 – Breakdown of household assets

Source: OECD, PwC calculations

-200

-100

0

100

200

300

400

500

mortgagesotherliabilities

other financialassets

othernon-financial

assets

pensionslife insurancehousing

3.9 – Summary and conclusions

The housing market presents a series of challenges and opportunities for business and policy makers alike. Access to finance for house purchase and the supply of affordable owner occupied and rental properties (private and social) are likely to remain key issues. The actions taken could have significant economic and social impacts.

The housing market will likely stay flat in the short term, but should return to growth once the outlook for the wider economy becomes more optimistic. The Eurozone crisis remains a key downside risk to the outlook.

In the long run, the growth of house prices is likely to be far more subdued than it was prior to the crisis with credit conditions keeping demand in check. However, house prices are likely to likely remain high relative to average income and increasingly unafford-able for young people as the supply of houses is unlikely to keep up with demand.


3.10 – Appendix

The PwC House Price Model

Our house price model is an econometric model with an error correction structure. It is driven by a long-run relationship between house prices, supply, credit and earnings. In the short-term, changes in house prices are driven by deviations from the long-run equilibrium, credit conditions, the cost of borrowing and the growth in the population aged between 25 and 44 (denoted ‘young population’ in the tables below). The coefficients for the variables are shown in the table below. In the model building process variables (including lags and differences where appropriate) of the supply growth just in London and the South East, unemployment, the exchange rate, government bond yields, the FTSE, nominal mortgage rates (buyers may put too much weight on nominal as opposed to real rates) and earnings of the top 10% and 25% of people were rejected as they weren’t significant at the 5% level.

R-squared 0.88 Dependent variable House prices Coefficient p-value

Earnings 18.3 0.000Supply -431.2 0.000Credit 2743.2 0.012Constant 120417.7 0.000

Longrun (Cointegrating) equation

Note: ‘D.’ Refers to the first difference of a variable, whilst ‘L.’ And ‘L2.’refer to the first and second lags respectively. Where appropriate variables are in real terms.

R-squared 0.89 Dependent variable D.house prices Coefficient p-value

L.Co-integrating equation -0.6 0.000Mortgage rate -313.6 0.025L.Mortgage rate -859.2 0.000Credit 3568.2 0.000D.Young population 16.6 0.000L2D. Young population 7.7 0.008Constant 4790.6 0.000

Short-run model

In our central scenario we assume that population grows in line with ONS projections. The number of houses per person is assumed to grow after 2013; in the long run it grows at a similar rate to the one seen in the 80s and 90s. In the modelling we cannot account for unknown changes in policy, particularly in relation to house-building which adds another dimension of uncertainty; however we make a reasonable assumption that in the long-run it will more closely reflect the growth in population. Unemployment is assumed to move according to the OBR

March 2012 fiscal and economic outlook, although we use a lower value for unemployment this year and next, given recent data has shown a decline in unemployment. We assume credit conditions remain as they are for this year and next, before returning gradually to conditions similar to those seen in the mid to late 90s. The base rate stays low for the next couple of years before gradually returning to 5% in the long-run. The spread of the average mortgage rate over the base rate falls slightly between the short and long-run to 3ppts.


Key points

• During the rapid economic expansion of the decade preceding the global financial crisis, the UK economy recorded impressive growth relative to others in its G7 peer group. The UK also achieved reductions in unemployment, low and stable inflation, and high growth in labour productivity over this period.

• The recession of 2008-9 saw sharp contractions in output across the G7, but the UK was one of the hardest hit. This was accompanied by UK inflation being the highest in the G7 and its unemployment rate increasing.

• Over the recovery period since mid-2009, growth in the UK has remained relatively weak in comparison to the US, Germany, Canada, France and Japan, while UK inflation and (to a lesser degree) unemployment has continued to rise. The UK has reduced its structural budget deficit more than any other G7 country since 2009, but the wider economic benefits of this have yet to come through.

• Medium term growth prospects for the UK should be better, however, with both inflation and unemployment rates expected to fall back over the next few years.

• Short-term policy responses are limited due to the UK government’s commitment to deficit reduction and an already accommodative monetary policy, so the priority should be to pursue supply side

reforms that boost infrastructure, skills, innovation and efficiency in order to promote long-term growth.

Introduction

In this article we compare UK economic performance against that of the other G7 economies over the past 15 years. The rationale for looking at the G7 is that this the UK’s natural peer group as all are relatively large economies with broadly similar levels of economic development (in contrast, say, to the BRICs). By looking at performance relative to these economies, we can control at least in part for common international shocks that affected all of the G7 to varying degrees.

The purpose of looking at a longer period of 15 years is that, while many commentators have noted that UK economic performance over the course of the recovery period since mid-2009 has been relatively disappointing, this really needs to be set in a longer term context to be a meaningful comparison of economic performance.

The article is structured as follows:

4.1 – A historical review of economic performance: UK vs. other G7 economies

4.2 – Future projections: UK vs. other G7 economies

4.3 – Policy implications and conclusions – where do we go from here?

Box 4.1 provides a view from the US, while Box 4.2 at the end of the article provides a more detailed look at recent UK productivity performance by industry sector.

4.1 – A historical review of economic performance: UK vs. other G7 economies

In the following sub-sections we compare the UK’s economic performance against that of the other G7 economies in terms of five key factors: GDP growth, inflation, unemployment, productivity and the budget balance. The analysis is broken down into three sub-periods: the economic expansion up to the crisis (Q4 1997 to Q4 2007), the recession (Q1 2008 to Q2 2009)

4 – Historic performance and future prospects for the UK relative to other G7 economies

1 This recovery has faltered recently in the UK and some other G7 economies, but there has been no retreat yet into severe recession in any of these countries, so it still seems to make sense to look at the period since mid-2009 as a whole as one of post-recession recovery.

and the subsequent recovery1 (Q3 2009 to Q1 2012). It should be noted in reading the charts below that the first period is significantly longer, and so would carry more weight in any assessment of average performance over the past 15 years; but splitting the overall period up in this way makes sense in terms of distinct phases of the economic cycle.

i) GDP growth

Figure 4.1 shows average real GDP growth per annum over the three sub-periods for each of the G7 economies (listed here in alphabetical order with the exception of the UK). We can see that, in the decade prior to the recession, the UK recorded the second


Figure 4.1 – Real GDP growth in G7 economies since 1997

Source: OECD, ONS

-6

-5

-4

-3

-2

-1

0

1

2

3

4


Expansion(1997 Q4 - 2007 Q4)

Recession(2008 Q1 - 2009 Q2)

Recovery(2009 Q3 - 2012 Q1)

0.9%

2.4%2.1%

0.4%

2.9%

1.3%

2.8%

-4.2%

-3.5%

-4.8%-4.5%

-3.7%

-2.7%-2.5%

3.1%

0.9%1.4%1.6%

2.8%

2.2%

3.2%


highest average rate of economic growth (3.1% per annum) among the G7, slightly behind Canada but ahead of the US and the other large EU economies.

The recession hit all of the G7 hard, but the UK suffered one of the steepest falls in output during 2008 and the first half of 2009 (at a 4.2% average annual rate, exceeded only by Japan and Italy among the G7). The UK’s performance over the subsequent recovery period has also been relatively weak, with average growth of just 0.9% per annum, being higher only than Italy among the G7.

Germany, Canada and the US stand out here as enjoying relatively strong economic recoveries since mid-2009, although even in those countries growth rates have not been spectacular, reflecting the ongoing drag from the financial crisis and problems in the Eurozone. See Box 4.1 for further reflections on US economic performance and prospects from a senior PwC economist in that country, who highlights the medium term fiscal challenges ahead.

The relative weakness of UK growth during and after the 2008-9 recession may, to a significant degree, be the consequence of a rate of expansion prior to the crisis that was, in retrospect unsustainable in its reliance

on a credit boom. The UK economy is still undergoing a period of post-crisis adjustment, but this is not to say that its growth rate will continue to underperform the G7 in the longer term once this adjustment is complete. We return to this issue in Sections 4.2 and 4.3 below, but first we review past trends in other key indicators.

ii) Inflation

The pre-crisis expansionary period was characterised by relatively benign inflation in the UK, as illustrated by the first set of bars in Figure 4.2. UK inflation averaged just 1.6% over this ten year period, somewhat below both the 2% target and the G7 average. Indeed over this period the UK enjoyed German levels of inflation but superior levels of growth.

As Figure 4.2 also shows, however, the period since 2007 has seen UK inflation pick up to significantly above both its 2% target rate and the levels seen in the other G7 economies. This probably largely reflects the sharp depreciation of sterling since mid-2007 and increases in VAT and other indirect taxes, as well as rises in global commodity prices that will also have affected other G7 economies. However, it is also possible that it could also reflect a more stubborn stickiness in UK pricing behaviour that could persist in the longer term.

“The US economy has grown modestly since the recovery began in the summer of 2009, but growth rates have lagged behind previous recoveries. As a result of the financial crisis and the fall in home prices triggering the recession, households have been reluctant to spend and business hesitant to expand. The global slowdown has added an additional weight to economic growth. Current projections are for slow but continued improvement, but these projections depend on the federal government’s response to the impending “fiscal cliff,” with the expiration of significant tax relief and scheduled cuts in government spending in 2013. The housing market is beginning to show signs of recovery, but access to credit remains a challenge.

Up to this point, the federal government has pursued an expansionary fiscal policy with little short-term cost. Interest rates in the US have fallen to historic lows, and inflation remains muted. The low inflation throughout the recovery has provided the Federal Reserve with room to exercise significant monetary expansion. However, additional monetary and fiscal stimulus is not anticipated at this time. While it is unlikely that the previously scheduled expirations of tax relief and automatic spending cuts will be allowed to go into effect in 2013 without modification, there is bipartisan recognition that the longer the US puts off addressing its structural budget deficits the higher the cost in the future.”John Stell, Director, US National Economics and Statistics practice, PwC

Box 4.1 – A view from the US: modest recovery with fiscal challenges ahead



Figure 4.2 – Consumer price inflation

Source: OECD*Latest data available for Japan April 2012

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

UKUSJPN*ITAGERFRACANUKUSJPNITAGERFRACANUKUSJPNITAGERFRACAN

Expansion(Dec ’97 - Dec ’07)

Recession(Jan ’08 - Jun ’09)

Recovery(Jul ’09 - May ’12)

3.6%

2.5%

-0.3%

2.4%

1.7%1.9%

2.3%

3.0%

1.8%

-0.3%

1.9%

0.9%1.1%

1.8%1.6%

-0.2%

2.3%

1.6%

2.7%

1.7%

2.2%

% of labour force change from start to end of each period

Figure 4.3 – Unemployment rate

Source: OECD, ONS

-6.0

-4.5

-3.0

-1.5

0.0

1.5

3.0

4.5

6.0


Expansion(1997 Q4 - 2007 Q4)

Recession(2008 Q1 - 2009 Q2)

Recovery(2009 Q3 - 2012 Q1)

0.4%

-1.0%-0.6%

2.0%

-2.4%

0.7%

-1.0%

2.7%

4.5%

1.2%1.2%

-0.6%

1.7%

2.5%

-1.4%

0.4%

-5.0%

-1.7%

0.1%

-3.4%-2.8%

iii) Unemployment

The UK unemployment rate fell by 1.4 percentage points over the course of the economic expansion to 2007 (as shown in Figure 4.3), although this good performance was only middling relative to the G7 average, as countries like Italy, France and Canada reduced unemployment levels even more significantly over this period.

In absolute terms, however, UK unemployment was relatively low on average throughout the period, particularly compared to the other large EU economies. So on this measure, the UK can be considered a relatively strong performer in the pre-crisis period.

During the recession, however, all G7 economies apart from Germany experienced an increase in their unemployment rates, with the UK experiencing the second largest increase, although less so than in the US and also markedly less than in the previous two UK recessions.

The rise in UK unemployment has continued during the recovery period since mid-2009, albeit to a much lesser degree than during the recession. Only Italy and France have seen less favourable unemployment trends during this recovery phase. Nonetheless, if we took the 15 year period since 1997

as a whole, the UK could still be considered a reasonably strong performer on unemploy-ment – the recent problem has been more in relation to weak productivity growth, as discussed further below.

iv) Labour productivity growth

As shown in Figure 4.4, the UK experienced strong growth in labour productivity during the period of economic expansion up to 2007 at an average annual rate of 2.2%. UK productivity growth surpassed that of all other G7 countries over this period.

One possible contributory factor for this may be that there was a marked increase in the number of skilled workers in the UK over this period: the proportion of adults with higher education or a degree qualification rose from 20.3% to 28.2% between 1997 and 2007 2, whereas the proportion of the unskilled (no secondary qualification) declined from 41% to 32% over the expansionary period. The latter was the largest decrease within the G7 over this period (see Figure 4.5).

The recession, however, took a serious toll on labour productivity across the G7, except for the US3 as shown in Figure 4.4. All G7 economies have seen some bounce-back in productivity since mid-2009, but this has been weaker in the UK than elsewhere as the final set of bars in Figure 4.4 illustrates.

2 Significantly increased immigration of skilled workers from Eastern Europe may also have played a part in this trend in the period since EU enlargement in 2004. 3 This can be seen as the counterpart of the large rise in US unemployment during the recession. This rise in joblessness was less severe in the UK, but only at the cost of much weaker productivity growth both during the recession and in the subsequent recovery period.


In Box 4.2 at the end of this article we provide a more detailed analysis4 of trends in UK productivity, which illustrates that the recent weakness was particularly evident in the services sector5, whereas manufacturing productivity has bounced back more strongly since mid-2009. Productivity trends in sub-sectors such as finance and insurance, and professional, technical and scientific services have been particularly negative (although these sectors also saw relatively strong pre-crisis productivity growth in most cases). Possible explanatory factors include labour hoarding by employers, sectoral interdependence causing inefficiencies from the finance and insurance sector to spill over to other services sectors, and tighter

credit conditions that may have limited productivity-enhancing new investment in these sectors.

v) Budget deficit

Over the period between 1997 and 2007, the government structural6 deficit increased in most of the G7 economies except Germany and Japan (see Figure 4.6). A relatively tough stance on government spending in the late 1990s meant that the UK actually built up a structural budget surplus between 1997 and 2000, but thereafter public spending increased rapidly and the UK structural deficit widened. As a result, the UK entered the 2008-9 recession in a potentially more vulnerable fiscal position than in 1997.


Figure 4.4 – Real labour productivity growth (output per worker)

Source: OECD, ONS

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0


Expansion(1997 - 2007)

Recession(2008 - 2009)

Recovery(2010 - 2011)

1.0%

2.3%2.1%

1.3%

2.4%

1.3%1.4%

-2.0%

0.6%

-2.3%

-2.7%-2.8%

-1.3%-1.1%

2.2%

1.2%

0.2%

1.1%

2.0%

1.1%1.2%

4 A similar analysis of UK productivity trends was published recently by the Bank of England and reached broadly similar conclusions: see A. Hughes and J. Saleheen, ‘UK labour productivity since the onset of the crisis – an international and historical perspective’, Bank of England Quarterly Bulletin, Q2 2012. Another interesting perspective is provided in recent research by Bill Martin and Bob Rowthorn (see their paper at: http://www.cbr.cam.ac.uk/pdf/BM_Report3.pdf), who argue that recent relatively weak UK productivity growth is more due to weak demand than supply side factors. In practice, both supply and demand side factors are likely to have been relevant, but disentangling these is difficult. 5 Although there could be measurement problems here that make these service sector productivity figures hard to interpret, as discussed in Box 4.2 in relation to financial services in particular. 6 The structural deficit is defined after adjusting for the estimated position in the economic cycle (as measured by the estimated output gap) and its impact on tax revenues and public spending.

Change as a % of GDP during each period

Figure 4.6 – Cyclically-adjusted general government budget balance

Source: OECD

-7.0

-6.0

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0


Expansion(1997 - 2007)

Recession(2007 - 2009)

Recovery(2010 - 2011)

2.6%

Reduceddeficit

Increaseddeficit

1.8%

-1.3%

1.3%

0.6%

2.6%

-0.2%

-5.1%

-5.8%

-4.4%

-0.3%

-1.0%

-2.3%

-4.4%

-2.6%

1.3%

-0.5%

1.6%

-3.1%

-1.7%

-.04%

Change as a % of adults from 1997 to 2007

Figure 4.5 – Share of adults with below upper secondary qualification

Source: OECD

-10.0

-9.0

-8.0

-7.0

-6.0

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

JapanGermanyUnited StatesCanadaFranceUnited Kingdom

-9.2% -9.0% -8.8%

-2.0%

-1.2%

0.0%


From 2007 to 2009 the deterioration in the UK budget deficit (both headline and structural) was second only to the US as a proportion of GDP. Government austerity measures have had a positive impact on the structural budget balance in most G7 countries (except Canada and Japan) during the recovery period since 2009, with the UK showing the second largest reduction in the structural deficit between 2009 and 2011 as shown by the final set of bars in Figure 4.6. This austerity programme may not have helped growth in the short term, although its negative effects should not be overstated given that it has allowed monetary policy to stay looser for longer than would otherwise have been the case, but it should be of some benefit in the longer term as discussed further below.

4.2 – Future projections: UK vs. other G7 economies

The UK economic outlook is projected by the IMF to improve over the medium term, with estimated average real GDP growth of just over 2% over the 5 years from 2012 to 2016, which would make the UK economy the third fastest growing in the G7, behind only the US and Canada (see Figure 4.7). The OBR’s forecast is slightly more optimistic than that of the IMF, putting average annual UK growth on a par with Canada at 2.3%.

If achieved, this would represent a significant improvement on the recent weak UK recovery, but it would still be a relatively modest rate

of growth for the recovery phase of the cycle relative to UK historical performance in the 1980s and 1990s. This reflects the continued overhang from the global financial crisis and the subsequent Eurozone sovereign debt crisis.

Over the medium term UK inflation is expected by the IMF to remain the highest among its G7 peers (see Figure 4.8), but this gap will narrow relative to that seen in the recession and recovery periods (see Figure 4.2 above) as one-off effects from the fall in sterling in 2007-8 and later VAT rises fall out of the calculation. However, the possibility of further rises in global commodity prices as and when the world economy recovers from its current malaise does represent an upside risk to inflation in the UK and elsewhere in the G7.

UK unemployment is expected by the IMF to peak in 2012 and decline thereafter in line also with the expectations of most other forecasters (including the OBR, which is more optimistic than the IMF on unemployment). Both the IMF and OBR see the UK’s medium term performance on unemployment to be one of the best in the G7 as shown in Figure 4.9.

Labour productivity growth in the UK is also expected to improve in 2012-13 relative to the period since mid-2009, although its performance is still middling in comparison to the rest of the G7 (see Figure 4.10).

% per annum average: 2012-16

Figure 4.8 – Projected average G7 inflation rates

Source: IMF, OBR

0.0

0.5

1.0

1.5

2.0

2.5

United KingdomCanadaGermanyUnited StatesFranceItalyJapan

0.3%

1.6%

1.9%

Same as OBR forecast

1.9%2.0%

1.9%

2.1%

% per annum average: 2012-16

Figure 4.7 – Projected average real GDP growth in G7

Source: IMF, OBR

0.0

0.5

1.0

1.5

2.0

2.5

3.0

ItalyGermanyFranceJapanUnited KingdomCanadaUnited States

2.8%

2.3% 2.3% OBR forecast

2.1%

1.5%

1.2%

1.4%

0.1%


Medium term projections are less readily available for productivity growth, but the general impression is that the relatively poor UK performance of recent years compared to its G7 peer group is expected to be only transitory by the IMF and OECD.

As illustrated in Figure 4.11, the IMF expects UK structural deficit reduction over the medium term to outpace that in other G7 economies, continuing the broad trend seen since 2009. This should support continued relatively low long-term interest rates in the UK, which in turn should be positive for longer term UK growth and investment, although how fast these benefits come through remains uncertain.

4.3 – Policy implications and conclusions: where do we go from here?

The analysis above shows that UK experience over the past 15 years has been mixed relative to its G7 peer group. The period of economic expansion between 1997 and 2007 was characterised by relatively strong UK GDP and productivity growth, falling unemployment and low inflation. However, this period of relative UK over-performance came to an end with the recession and has continued through a relatively weak recovery period in the UK since mid-2009 during which inflation has remained stubbornly high and productivity growth surprisingly weak (although there may be measurement

problems here given this issue seems to be focused on the services sector).

Looking ahead, the IMF and most other forecasters expect that relative UK under-performance will prove temporary, although growth may remain relatively subdued for some years relative to similar periods in the economic cycle in the 1980s and 1990s. The one strong point in recent UK performance – a relatively rapid reduction in the structural budget deficit since 2009 – may not have paid dividends yet, but should do so in the medium-term.

Policymakers in the UK are rightly concerned about the UK’s growth prospects in the short-term given the ongoing uncertainties about the stability of the Eurozone. This is already leading to new initiatives by the Bank of England and the Treasury to support bank liquidity and funding for lending to small- and medium-sized businesses, although room for manoeuvre on fiscal policy remains more limited7.

However, as argued in detail in an article in the previous UK Economic Outlook by our senior economic advisor, Andrew Sentance, the most important task for policy is to enact supply side reforms that support a long-term growth agenda. The UK government’s corporate tax reform agenda has been helpful here but needs extending to other areas of tax policy. Active labour market measures are needed to combat youth

7 Although temporary targeted fiscal stimulus measures could be considered if there were further severe adverse shocks from the Eurozone.

% per annum on average: 2012 and 2013 only

Figure 4.10 – Projected G7 labour productivity growth

Source: OECD

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

ItalyUnited StatesFranceGermanyUnited KingdomCanadaJapan

1.9%

1.5%

1.2%

1.0%0.9%0.9%

-0.7%

as % of labour force: 2012-16

Figure 4.9 – Projected change in G7 unemployment rates

Source: IMF, OBR

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

GermanyJapanItalyCanadaFranceUnitedKingdom

UnitedStates

-1.8%

-1.3%

-2.4% OBR forecast

-0.8%-0.7%

-0.4%

-0.6%

-0.4%


unemployment in particular and regulatory burdens on job creation need to be loosened where possible. The government should pursue further current initiatives to boost infrastructure investment through loan guarantees and other measures to leverage increased private sector investment from institutional investors such as pension funds and sovereign wealth funds.

This policy programme also needs to include ensuring that the labour force has the necessary skills to take advantage of growth as and when it returns. Existing expertise in skills-reliant service sectors can be harnessed to the UK’s advantage, such as healthcare, financial services, professional and scientific services, and creative industries. The UK also

has a potential comparative advantage in the higher education sector, in that the UK is home to some of the world’s top research universities, which can be vital to innovation. In addition, the strengthening of market competition and corporate governance are important for sustainable growth, including necessary post-crisis reforms to the financial sector and sound banking regulations that balance the costs and benefits to the economy of such measures.

Such policy measures, if pursued consistently over the next few years, should help to restore relative UK economic performance in the long term to the positive position relative to the rest of the G7 seen in the pre-crisis period.

In this box we explore in further detail the key productivity trends in the UK since 1997, focusing in particular on the question of which industry sectors have driven the comparatively weak UK productivity growth seen over the recovery period since mid-2009.

In the decade prior to the recession, UK productivity growth was strong, with output per hour increasing at an average rate of 2.4% per annum as shown in Figure 4.12. Manufacturing productivity grew particularly rapidly over this period, but services sector productivity also rose significantly.

During the recession, however, UK productivity declined sharply, with output per hour falling fastest in the services sector, probably in part due to labour hoarding in that sector, whereas job cuts were more marked in manufacturing, which cushioned the blow to manufacturing productivity and allowed it to bounce back sharply after the recession as shown in Figure 4.12.

One of the more striking features of the recovery period, however, has been the slow productivity growth in the services sector, which averaged only 0.5% per annum between Q2 2009 and Q1 2012 and

2016 vs 2011 as a % GDP

Figure 4.11 – Projected change in budget balance

Source: IMF

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

JapanGermanyItalyFranceCanadaUnitedStates

UnitedKingdom

Cyclically-adjusted budget balance Headline budget balance

5.2%

6.6%

3.2%

5.1%

2.9%

3.8%

2.7%

4.0%

2.6% 2.6%

0.9% 0.8%0.6%

2.5%

Reduceddeficit

% per annum change on average in output per hour over periods shown

Figure 4.12 – UK labour productivity growth by sector

Source: ONS

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

Recovery(2009 Q3 - 2012 Q1)

Recession(2008 Q1 - 2009 Q2)

Expansion(1997 Q4 - 2007 Q4)

Whole economy Manufacturing Services

2.4% 2.4%

4.5%

0.7%0.5%

2.8%

-2.2%

-1.6%-1.3%

Box 4.2 – UK productivity trends by industry sector


dominates overall average UK productivity growth trends. However, it should be noted that productivity in the services sector is particularly vulnerable to measurement error owing to difficulties in quantifying the value of services and labour inputs and accounting for changes in quality. So we should treat these figures with a degree of caution, particularly those for the last year or two that may later be revised significantly by the ONS. Nonetheless, the relative under-performance of service sector productivity has been stark in recent years and therefore merits further exploration.

Figure 4.13 shows the productivity performance of key services sub-sectors. We can see that most of these services sectors saw sharp declines during the recession (except real estate services for reasons that are not entirely clear). Moreover, important sub-sectors such as finance and insurance, and professional, scientific and technical services have continued to record negative productivity growth during the recovery period after mid-2009, contrary to normal cyclical trends. In particular, the body blow inflicted on the finance and insurance sector by the global crisis seems to have resulted in long-lasting productivity losses, despite employment cuts in this sector.

One possible explanation for relatively weak recent productivity performance in some parts of the services sector could be sectoral interdependence, with the resulting productivity loss in the finance8 and insurance sector and inefficiencies in the allocation of capital spilling over to other sectors, in particular to professional, scientific and technical services. Moreover tighter credit conditions have reduced the capital that firms can use to fuel investment and productivity growth. Businesses may also have engaged in labour hoarding as lower real wages cushioned business profitability and preserved employment despite the sharp decline in economic activity during the recession. Reduced hours worked could also mean fewer opportunities for workers to acquire skills, thus further lowering productivity growth.

In summary, recent weak UK productivity growth seems to be concentrated in parts of the services sector, notably finance and insurance. Although measurement difficulties could have exaggerated these trends, they do seem to be a natural counterpart of maintaining relatively high employment levels in services sectors, while manufacturing has seen stronger productivity growth at the expense of larger job cuts.

% per annum change on average in output per hour over periods shown

Figure 4.13 – Labour productivity trends in key services sub-sectors

Source: ONS

-10

-8

-6

-4

-2

0

2

4

6

8

Expansion(1997 Q4 - 2007 Q4)

Recession(2008 Q1 - 2009 Q2)

Recovery(2009 Q3 - 2012 Q1)

-0.8%

-3.1%

0.4%

1.4%

0.3%

4.5%

-0.1%

4.7%

-1.7%

-3.2%

1.1

-8.8%

-5.1%

-2.5%-2.6%

2.4%

6.4%

2.0%

4.5%

2.5%

4.2%

Rea

les

tate

Fina

nce

&in

sura

nce

Who

lesa

lean

d r

etai

l

Info

&co

mm

s

Tran

spor

t &

stor

age

Ad

min

&su

pp

ort

Pro

fess

iona

l &sc

ient

ific

Rea

les

tate

Fina

nce

&in

sura

nce

Who

lesa

lean

d r

etai

l

Info

&co

mm

s

Tran

spor

t &

stor

age

Ad

min

&su

pp

ort

Pro

fess

iona

l &sc

ient

ific

Rea

les

tate

Fina

nce

&in

sura

nce

Who

lesa

lean

d r

etai

l

Info

&co

mm

s

Tran

spor

t &

stor

age

Ad

min

&su

pp

ort

Pro

fess

iona

l &sc

ient

ific

8 What we are seeing in the financial sector may also just reflect a squeeze in margins as the value of banking activities get revised down post-crisis. Staff may still be working just as hard as before, but the market value of what they produce has just declined following the crisis. Distinguishing price, quality and volume effects in finance is particularly difficult, so official productivity statistics may not fully capture what is going on here at the microeconomic level.


Source: Latest PwC main scenario for 2012-13; IMF for GDP shares in 2011 at market exchange rates (MERs),which are generally more relevant for business purposes than shares based on GDP at PPPs.

Country Share of GDP growth (%) Consumer price World GDP inflation (%) (%: 2011) 2012 2013 2012 2013

United States 21.7 2.3 2.6 2.3 2.1

Canada 2.5 2.1 2.3 2.1 2

Germany 5.1 0.4 1.3 1.8 1.6

France 4.0 0.3 0.9 1.6 1.5

United Kingdom 3.5 0.0 1.7 2.9 2.2

Italy 3.2 -1.7 -0.2 2.5 1.6

Spain 2.1 -2 -0.1 1.5 1.4

Netherlands 1.2 -0.9 0.7 2.3 2.2

Greece 0.4 -6.9 -1.1 0.6 1.8

Portugal 0.3 -2.1 0.1 2.6 1.6

Ireland 0.3 -0.6 1.6 1.6 1.3

China 10.5 8 8.5 3.4 3.6

Japan 8.4 2.2 1.4 -0.2 0.1

India 2.4 5.8 6.5 7.2 6.5

Australia 2.1 3.1 3.5 1.7 2.7

Korea 1.6 3 3.5 2.8 2.9

Indonesia 1.2 6 6.3 4.9 5.7

Saudi Arabia 0.8 4.8 4.2 4.8 4.5

Russia 2.7 3.9 4.2 4.8 6.2

Turkey 1.1 2.3 4 9 6.4

Poland 0.7 2.6 3.1 3.5 2.6

Brazil 3.6 2.3 3.9 5.3 5.3

Mexico 1.7 3.6 3.8 3.7 3.7

Argentina 0.6 3.3 3.3 9.9 10.2

South Africa 0.6 2.5 3.2 5.8 5.2

Table A.1 – Global economic prospects

Appendix A – Outlook for the global economy

Table A.1 presents our latest main scenario projections for a selection of economies across the world. Most economies show some slowdown in 2012, particularly in the Eurozone, but then a gradual recovery in growth in 2013.

These projections will be updated more regularly on our website at http://www.pwc.co.uk/the-economy/index.jhtml and during the summer we plan to launch a new monthly Global Economy Watch briefing paper that will give a concise commentary on key developments and prospects for the major economies.

World (PPP weights) 3.4 3.9 3.2 3.1

World (market rates) 2.7 3.2 2.7 2.7

Eurozone (market rates) -0.7 0.6 1.9 1.6

GDP-weighted averages GDP growth (%) Consumer price inflation (%) 2012 2013 2012 2013

Source: Latest PwC main scenario projections.

Appendix B – UK economic trends: 1979 – 2011


Source: ONS, Bank of England

* Pre-1997 data estimated** Public Sector Net Borrowing (calendar years)† Peak-to-peak for GDP relative to trend

Average over economic cycles†

1979 - 1989 2.7 3.9 0.9 - 12.2 -0.8 2.5

1989 - 2000 2.7 3.2 0.8 3.1 7.8 -2.0 2.9

2000 - 2007 3.0 3.2 0.0 1.7 4.7 -2.1 2.2

Annual GDP Household Manufacturing Inflation 3 Month Current PSNB**averages growth expenditure output (CPI*) interest rate account (% of GDP) growth growth (% annual balance average) (% 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 12.3 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 -1.7 1.5

1988 5.6 8.4 7.3 10.4 -4.1 -0.8

1989 2.6 3.9 4.0 5.2 13.9 -4.9 -0.8

1990 1.8 2.4 -0.1 7.0 14.8 -3.8 0.7

1991 -1.8 -2.4 -5.0 7.5 11.5 -1.8 3.0

1992 0.9 1.5 -0.1 4.3 9.6 -2.1 6.5

1993 3.1 4.0 1.5 2.5 5.9 -1.9 7.8

1994 4.6 3.2 4.7 2.0 5.5 -1.0 6.6

1995 3.2 2.0 1.5 2.6 6.7 -1.4 5.3

1996 3.1 4.9 0.6 2.5 6.0 -0.9 3.7

1997 3.9 4.8 2.3 1.8 6.8 -0.1 1.9

1998 3.5 4.3 0.8 1.6 7.3 -0.4 -0.1

1999 3.2 5.2 0.8 1.3 5.4 -2.7 -1.3

2000 4.2 5.3 2.4 0.8 6.1 -2.9 -1.7

2001 2.9 3.9 -1.6 1.2 5.0 -2.3 -0.8

2002 2.4 4.1 -2.6 1.3 4.0 -2.1 1.8

2003 3.8 3.7 -0.2 1.4 3.7 -1.7 3.0

2004 2.9 3.3 2.1 1.3 4.6 -2.1 3.1

2005 2.8 2.7 -0.1 2.1 4.7 -2.1 3.3

2006 2.6 1.6 1.8 2.3 4.8 -2.9 2.4

2007 3.6 2.8 0.9 2.3 6.0 -2.3 2.5

2008 -1.0 -1.6 -2.5 3.6 5.5 -1.0 4.8

2009 -4.0 -3.0 -9.7 2.2 1.1 -1.3 10.9

2010 1.8 1.3 3.8 3.3 0.7 -2.5 9.9

2011 0.8 -1.1 2.1 4.5 0.9 -1.9 8.2


Contacts and services

Competition policy and regulation,litigation support, financial economics,health economics and business strategy

David LancefieldTim OgierNick ForrestLuisa AffusoDaniel HansonEd Bramley-Harker

020 7213 2263020 7804 5207020 7804 5695020 7212 1832020 7804 5774 020 7804 5684

Energy, utilities and infrastructureOil and gas

Mark HughesMark Hurley

020 7804 5767020 7804 4465

Environmental economics, climate change and sustainability

Richard GledhillGeoff LaneAndrew Thurley

020 7804 5026020 7213 4378020 7212 6503

Macroeconomics Andrew SentanceJohn HawksworthWill Zimmern

020 7213 2068020 7213 1650020 7212 2750

Project appraisal and financing, transport Julian Smith 020 7804 5840

Policy research and evaluationImpact assessment and benefits appraisalCustomer focused public servicesPublic sector research centre

David ArmstrongMark AmblerMark GrahamNick Jones

02890 415716020 7213 15910131 260 4054020 7213 1593

Regional and local economic development,inward investment

Ray Mills 0191 269 4284

Telecommunications and media David LancefieldAlastair MacPhersonRolf Meakin

020 7213 2263020 7213 4463020 7213 1707

Economics

UK Economic Outlook is produced three times a year by the macroeconomics team at PricewaterhouseCoopers (PwC). The present report was written by John Hawksworth, Yong Jing Teow and Rachel Lund. For more information about the technical content of this report please contact: John Hawksworth ([email protected]) or Rachel Lund ([email protected])

We also publish a wide range of international economic briefings and forecasts on our PwC Economic Views portal (www.economics.pwc.com).

In addition, we provide a range of macroeconomic consulting services for clients, including:

• Revenue forecasting

• Stress testing

• Economic impact analysis

For enquiries concerning these services, please contact Will Zimmern on 020 7212 2750 or visit www.economics.pwc.com

The PwC economics practice offers a wide range of services, covering competition and regulation issues, litigation support, bids and business cases, public policy and project appraisals, financial economics, the economics of sustainability and macroeconomics.

For more information about these services please visit our website (www.pwc.co.uk/economics) or contact:

We are currently updating the format of UK Economic Outlook. In response to reader feedback and PwC’s own sustainability drive the updated version will not be available in hardcopy. This will enable us to improve the functionality of the report as well as reduce our impact on global resources.

To receive future editions by e-mail please sign up on our website www.pwc.co.uk/the-economy or e-mail [email protected]

www.pwc.co.uk/economics© 2012 PricewaterhouseCoopers LLP. All rights reserved. In this document, “PwC” refers to PricewaterhouseCoopers LLP (a limited liability partnership in the United Kingdom),which is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity.

Designed by PwC Design and Media 07/12

uk economic outlook july 2012

Documents