UK Economic Outlook July 2017

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2 Contents Global outlook UK economic trends and prospects UK housing market outlook Nowcasting current GDP growth PwC 2

3 Global growth in 2017 should be slightly stronger than in 2016 Canada 2.0 Ireland 3.6 UK 1.5 Germany 1.5 Russia 1.1 US 2.2 France 1.5 Greece 1.6 Mexico 1.5 Global (MER) 2.9% Global (PPP) 3.4% Eurozone 1.6% Spain 2.3 Italy 1.0 India 7.3 China 6.5 Japan 1.0 Australia 2.7 Key Country x.x = % GDP growth in 2017 Source: PwC main scenario PwC Brazil 0.4 South Africa 0.9 3

4 UK economic trends and prospects

5 Growth in UK services has been strong since the recession, but manufacturing and construction have lagged behind Figure 2.1: Sectoral output and GDP trends 120 Index (Q = 100) Services GDP Construction Manufacturing Q Q Q Q Q Q Q Q Q Q3 Services GDP Manufacturing Construction Source: ONS PwC 5

6 % change on previous quarter Growth in consumer spending and the services sector slowed in Q1 2017, contributing to weaker GDP growth Figure 2.2: Trends in GDP, consumer spending and the services sector 1.0% 0.8% 0.6% 0.4% 0.2% 0.0% Q1 Q2 Q3 Q4 Q GDP Consumer expenditure Services Source: ONS PwC 6

7 Relatively strong post-brexit trends in the services and manufacturing sectors have tailed off in recent months Figure 2.3: Purchasing Managers Indices of business activity Services Above 50 indicates Manufacturing Downward blip after Brexit vote JAN 2008 JAN 2009 JAN 2010 JAN 2011 JAN 2012 JAN 2013 JAN 2014 JAN 2015 JAN 2016 JAN 2017 JAN Source: kit/cips PwC 7

8 Concerns about Brexit have left sterling weak against the dollar and euro, pushing up UK import prices and inflation Figure 2.4: US dollar and euro exchange rates against the pound USD/ EUR/ JAN 2016 FEB 2016 MAR 2016 APR 2016 MAY 2016 JUN 2016 JUL 2016 AUG 2016 SEP 2016 SEP 2016 OCT 2016 NOV 2016 DEC 2017 NOV 2017 MAR 2017 MAR 2017 MAY 2017 JUN Source: Bank of England PwC 8

9 Nominal wage growth Low levels of unemployment no longer pushing up UK wage growth due to low unionisation and a more flexible workforce Figure 2.5: UK Phillips Curve shifts and flattens over time 35% 30% 25% 20% 15% 10% 5% 0% 2% 4% 6% 8% 10% 12% Unemployment rate -5% Linear ( ) Linear ( ) Linear ( ) Source: kit/cips PwC 9

10 UK growth is likely to ease in due to Brexit-related uncertainty and slowing consumer spending growth Figure 2.6: Alternative UK GDP growth scenarios 4% 2% 0% Projections Strong growth Main scenario Mild recession -2% -4% -6% -8% 2007 Q Q Q Q Q Q Q Q Q Q Q Q Q1 Source: ONS, PwC scenarios PwC 10

11 London growth has slowed but remains above UK average - all regions projected to have positive but modest growth Figure 2.7: PwC main scenario for output growth by region in 2017 and % % 1.6% 1.4% 1.2% 1.0% 0.8% 0.6% 0.4% 0.2% 0.0% London England South East South West UK East Midlands East Anglia North West North East Wales Yorkshire & Humberside Scotland West Midlands N Ireland Source: PwC analysis PwC 11

12 UK inflation heading above 3% later this year in our main scenario but considerable uncertainties remain Figure 2.8: Alternative UK inflation (CPI) scenarios 5% 4% % change on a year earlier Projections High inflation 3% 2% Inflation target = 2% Main scenario 1% Low inflation 0% 2010 Q Q Q Q Q Q Q Q Q1 Source: ONS, PwC scenarios PwC 12

13 Real earnings growth is projected to remain negative as inflation picks up and wage growth stays subdued Figure 2.9: CPI inflation vs average earnings growth 5.0% % change p.a. Projections CPI 4.0% 3.0% 2.0% Real squeeze Earnings 1.0% 0.0% Source: ONS, PwC analysis PwC 13

14 Summary: UK economic trends and prospects The UK economy grew by 2% in the year to Q1 2017, but the quarterly rate fell to 0.2%, primarily as a result of a softening in consumer spending and services growth. In our main scenario, we project UK growth to slow to 1.5% in 2017 and 1.4% in The UK would avoid recession in this scenario, although risks to growth are still weighted somewhat to the downside given the uncertainties associated with Brexit. We project that London could remain the fastest growing UK region in , but its pace of expansion is expected to slow significantly from earlier rapid rates. Other regions are projected to see average real growth in of around 1-1.5%, but we do not predict negative growth in any region in our main scenario. Wage growth continues to be subdued despite the lowest unemployment rate since This suggests that the traditionally negative relationship between these two variables, as described in the Phillips Curve, may have broken down. Consumer price inflation is likely to rise above 3% later this year. This continues to be driven by the exchange rate depreciation since the Brexit vote, although this effect could start to fade later in 2018 if wage growth remains subdued. PwC 14

15 UK housing market outlook PwC 15

16 Our latest analysis of the UK housing outlook covers: 1. Recent housing market developments 2. The outlook for UK and regional house prices: updated projections to The impact of government housebuilding targets on these projections 4. Local housing market trends PwC 16

17 Year-on-year % change House price inflation did not react to Brexit as quickly as some expected, but has shown signs of slowing during 2017 Figure 3.1. Annual rate of house price inflation 15% EU referendum 10% 5% 0% -5% % -15% -20% Source: ONS PwC 17

18 Transaction volumes appear to have suffered more from Brexit, but these effects are compounded by other factors such as stamp duty reform Figure 3.3. Annual growth in UK housing transactions 100% 80% 60% Stamp duty reform effective EU referendum 40% 20% 0% -20% % -60% -80% Source: ONS PwC 18

19 % change on year earlier In our main scenario, we project house prices to rise at a modest rate of 3.7% in 2017, but to continue to outstrip earnings growth in the medium term, averaging around 4% Figure 3.4. UK house price inflation main scenario projection 20% 15% 10% 5% 0% % -10% Source: ONS house price index historical data, PwC projections PwC 19

20 An increase in housebuilding in line with government targets would be welcome, but might only reduce the average UK house price by around 5,000 in 2025 Government housebuilding targets: a million homes by 2020 and half a million more by 2022 Table 3.3. UK house prices the potential impact of increase supply Current trends would project 216,000 new homes a year by Increasing that to 250,000 a year would increase housing stock growth from 0.9% to 1.1% a year. Source: PwC analysis using the ONS house price index and DCLG new supply of housing PwC 20

21 We project that London s house price growth will slow down significantly, to below the UK average, while the East and other southern English regions will remain stronger Figure 3.5. Projected house price inflation in UK regions 2017 and % 5% 4% 3% UK average 2018 UK average % 1% 0% East of Yorkshire England and The Humber South West West Midlands London North West Source: PwC analysis based on ONS house price index PwC 21 South East North East East Midlands Wales Scotland Northern Ireland

22 In our low scenario, a more severe impact from Brexit on earnings growth and tighter credit conditions could see house price inflation average only around 1% in the medium term, but there are also upside possibilities Figure 3.6. Alternative UK house price inflation scenarios 20% 15% 10% 5% 0% % -10% Baseline scenario High scenario Low scenario Source: PwC analysis based on ONS house price index PwC 22

23 A quarter of all UK local authorities still have house prices below their pre-crisis 2007 peaks, with the sharpest shortfall being seen in Northern Ireland and the North East Figure 3.7. Local authority areas where house prices are still below pre-crisis peak levels in 2007 Source: ONS/Land Registry; PwC analysis PwC 23

24 Since 2014, there has been a marked shift in the pattern of house price growth within the capital, as the outer boroughs saw much larger rises than their inner London boroughs Figure 3.8. Relative cumulative house price rises in London boroughs ( ) Figure 3.9. Relative cumulative house price rises in London boroughs ( ) Source: ONS/Land Registry; PwC analysis PwC 24

25 The challenging affordability outlook in London has also seen housing demand, and therefore prices, grow faster in the commuter belt since the start of 2016 Figure The fastest growing commuter towns and cities by house price growth ( ) Source: ONS/Land Registry; PwC analysis PwC 25

26 Summary: UK housing market prospects House prices in the UK were not impacted by the Brexit vote as quickly as some expected, but has weakened in early Transaction volumes appear to have suffered more, but these effects were compounded by other factors such as stamp duty reform. We anticipate that the slowdown in the housing market will continue for the rest of 2017, yielding annual house price growth of only around 3.7%, down from 7% in This could be felt the hardest in London, where we project house price rises to slow to below the UK average in Whilst increasing homebuilding to the government s target of 250,000 a year is welcome and might restrict future house price growth slightly, it is unlikely to provide a quick fix to the affordability problem given many past decades of under-supply. There has been a structural shift in London s housing market over the past few years as house price growth has moved outwards from the centre in light of growing unaffordability and stamp duty reform. We expect this trend to continue, with commuter belts around London seeing stronger house price growth than the capital. PwC 26

27 Nowcasting current GDP growth PwC 27

28 The ONS releases a preliminary estimate of GDP growth around a month after the end of each quarter. Figure 4.1. Timeline of the preliminary ONS GDP data release Quarter Lag ONS preliminary estimate of GDP Time Month 1 Month 2 Month 3 Month 4 Source: ONS, PwC PwC 28

29 Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Absolute size of revision (% QoQ growth) and these preliminary ONS estimates are often revised significantly before the final estimate, though these revisions have declined since the crisis Figure 4.2. The absolute size of revisions to UK GDP growth Pre-crisis average: 0.36% average 0.61% Post-crisis average: 0.19% Source: ONS, PwC PwC 29

30 RMSE (% QoQ) Central banks and others have developed nowcasts as more timely estimates of current GDP growth Figure 4.3. Performance of UK nowcasting models 0.6% 0.5% Relative to final GDP Relative to preliminary GDP 0.4% 0.3% 0.2% 0.1% 0.0% NIESR, 2009 (2001Q2-08Q4) Mitchell, 2009 (2001Q2-08Q4) ONS preliminary estimate (2001Q2-08Q4) Bank of England, 2014 (2004Q1-13Q4) Source: Mitchell (2009), Bank of England (2017), ONS, PwC PwC 30

31 Sector output indices are strong predictors of GDP, but including other indicators, such as house prices, materially improves our ability to nowcast movements in GDP Figure 4.5. Top 5 variables that impact our nowcasts over the past 4 years Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q4 2017Q1 ONS Services index ONS Industrial production index ONS Construction index ONS Retail sales index Nationwide House Price Index ONS Manufacturing Index Source: PwC PwC 32

32 GDP growth (% QoQ) Our nowcast suggests that GDP growth in Q will continue to be sluggish at around 0.3% (QoQ) Figure 4.6. UK GDP growth (% Q-on-Q) Q Q Nowcast Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Source: ONS, PwC PwC 33

33 GDP growth (% QoQ) This is driven by somewhat stronger growth in the services sector than in Q1 2017, offset by weaker production and construction sectors and house prices Figure 4.7. A decomposition of our Q GDP growth nowcast 0.40% 0.35% 0.30% +0.35% -0.06% +0.02% -0.03% -0.06% +0.03% +0.25% 0.25% 0.20% 0.15% 0.10% 0.05% 0.00% ONS Services index ONS Industrial production index ONS Retail Sales index ONS Nationwide house price index ONS Construction index All other variables Q Nowcast Source: PwC PwC 34

34 Summary: Nowcasting current GDP growth Businesses and policy makers need to keep a constant watch on the UK economy, but the preliminary ONS estimate of GDP growth is released with a significant lag after the end of each quarter. This creates the need for more timely indicators of current economic activity. Nowcasting models can meet this need by utilising frequently released information to assess current economic activity. They are used across the globe, most notably by central banks including the Bank of England. To provide a more timely estimate of GDP in the UK we have built our own nowcasting model utilising machine learning techniques. Our analysis shows that sector output indices are strong predictors of GDP growth, but the inclusion of other indicators, such as house prices, materially improves our ability to predict movements in GDP. Our nowcasting model suggests that GDP growth in the second quarter of 2017 will continue to be sluggish at around 0.3% relative to the previous quarter. This is up very slightly from the ONS estimate of 0.2% in the first quarter of 2017 due to somewhat stronger growth in the services sector, offsetting weakness in the production and construction sectors. This suggests that the first half of 2017 will be the weakest six month period for UK GDP growth since 2012 during the Eurozone crisis. PwC 35

35 Contacts for more information about this report John Hawksworth (chief economist) / Richard Snook (housing) / Jonathan Gillham (nowcasting) / Lucy Rimmington (economist) / Jamie Durham (economist) / Sam Hinds, Hugh Dance and George Mason also made important contributions to the report, as did Andrew Sentance, our senior economic adviser. For more information on our Economics services or to access the full report, please see our website at: 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 PricewaterhouseCoopers LLP. All rights reserved. In this document, "PwC" refers to the UK member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see for further details.