ECONOMIC UPDATE UK focus - a year of slower growth? Professor Trevor Williams, University of Derby & Chair of the IEA s Shadow Monetary Policy Committee (SMPC) MAY 2016
UK RECOVERY STEADY THOUGH NOT SPECTACULAR PRE-CRISIS TREND IN GROWTH 2
UK OUTPERFORMS MANY OF ITS PEERS QUARTER ON QUARTER YEAR ON YEAR 3
ONLY BETTERED BY US AND MATCHED BY GERMANY 4
SERVICES DRIVE RECOVERY 5
AND HAS DONE FOR SOME TIME 6
ACCOUNTING FOR ALL OF THE GROWTH IN Q4 7
Manufacturing 100.3-1.9-1.3 0.1-0.4 Source: Office for National Statistics MANUFACTURING BACK IN RECESSION IN Q1 Figure 1: Seasonally adjusted production and manufacturing, December 2013 to March 2016, UK Source: Primarily Monthly Business Survey (Production and Services) - Office for National Statistics 8
LEVEL OF OUTPUT IS NO HIGHER THAN IN 1997 Figure 2: Index of production and sub-components, Quarter 1 (Jan to Mar) 1997 to Quarter 1 (Jan to Mar) 2016, UK Source: Primarily Monthly Business Survey (Production and Services) - Office for National Statistics Notes: 9
NO SURPRISE NET TRADE IS A DRAG OF GROWTH 5 4 % GDP 3 2 Current account deficit (4 qtr avg) Trade deficit (4 qtr avg) 1 0-1 -2-3 -4-5 -6 1971 1975 1979 1983 1987 1991 1995 1999 2003 2007 2011 2015 10
ESPECIALLY AS WORLD TRADE GROWTH IS SO WEAK World Trade, %Ch y/y 25% 20% 15% 10% 5% 0% 2000 2004 2008 2012 2016-5% -10% -15% -20% -25% 11
STERLING S SLIDE MAY EASE PRESSURE ON EXPORTERS & BOOST INFLATION 1.75 1.50 1.70 GBPUSD GBPEUR (RHS) 1.45 1.65 1.40 1.60 1.35 1.55 1.30 1.50 1.45 1.25 1.40 1.20 1.35 1.15 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Source: Bloomberg 12
HOUSEHOLD SPENDING DRIVES UK GDP GROWTH Net trade and Capital spending dragged on growth in Q4 13
HOUSEHOLDS ARE NOW NET BORROWERS 14
NO CREDIT CRISIS AS YET UK Net household lending % year 18 16 14 12 10 8 6 4 2 0-2 Mortgage lending Consumer credit Total household lending -4 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Source : Oxford Economics/Haver Analytics 15
TOTAL DEBT IS STUBBORNLY HIGH & A RISK TO RECOVERY? 120 Debt outstanding, % of gdp, sa Nonfinancial Corporations 600 Total domestic Debt Outstanding 100 500 Households 80 400 60 300 Financial Corporations debt UK: General Government debt 40 08 09 10 11 12 Source: Office for National Statistics/Haver Analytics 13 14 15 200 08 09 10 11 12 13 14 15 While debt service/disposable income ratios are by and large still manageable due to currently low interest rates, high debt levels - especially as a share of disposable income - have made the UK more vulnerable to adverse developments, such as slow growth, rising interest rates or declining house prices - or a combination of both of these. 16
UNDERPINNED BY UNDERSUPPLY House price growth holding up..and so are approvals Source: Office for National Statistics/Haver Analytics While debt service/disposable income ratios are by and large still manageable due to currently low interest rates, high debt levels - especially as a share of disposable income - have made the UK more vulnerable to adverse developments, such as slow growth, rising interest rates or declining house prices - or a combination of both of these. 17
THE SAVING RATIO IS FALLING Saving ratio now at lowest level since 1963, when records began in this form 18
BUT CORPORATE BALANCE SHEET LOOKING BETTER PNFC financial balance 4QMA, % of GDP 5 32 PNFC deposits 4QMA, % of GDP 4 30 3 28 2 26 1 24 0 22-1 2002 2004 2006 2008 2010 2012 2014 20 2002 2004 2006 2008 2010 2012 2014 Source : Haver Analytics Source : Haver Analytics 19
POPULATION GROWTH PULLS DOWN GDP PER HEAD SO PRODUCTIVITY MUST BE POOR 20
INDDED, PRODUCTIVITY IS ESPCIALLY POOR IN THE UK Labor productivity in mature countries is falling percent y/y, 5-year moving average 5 Germany Japan 4 3 United Kingdom United States 2 1 0-1 1990 1995 2000 2005 2010 Source: OECD, IIF. 21
FLIP SIDE IS THAT EMPLOYMENT GROWTH HIGHEST EVER 22
RAPID INCREASE IN THOSE IN EMPLOYMENT FROM EU 23
BUT PUBLIC SECTOR EMPLOYMENT IS FALLING 24
SERVICE (TECH) SECTOR JOBS GROWING FAST Changes in the number of jobs in the UK between December 2014 and December 2015, seasonally adjusted 25
PAY GROWTH SLOWING AS ECONOMY SLOWS 26
DESPITE LOW UNEMPLOYMENT 27
CONSUMER FUNDAMENTALS REMAIN STRONG 6.0 4.0 2.0 0.0-2.0 Real wages, %yr Unemployment rate, % 9.0 8.5 8.0 7.5 7.0 6.5 6.0-4.0-6.0 Real wages (3-mth %yr, LHS) Unemployment rate (%, RHS) 5.5 5.0 4.5-8.0 2005 2007 2009 2011 2013 2015 4.0 28
CONSUMER CONFIDENCE IS HOLDING UP % y/y net balance 10 8 6 4 2 Consumption (LHS) 25 15 5-5 0-2 -4-6 GfK consumer confidence (RHS) -15-25 -35-8 1974 1983 1992 2001 2010-45 29
SO A CONTINUED CONSUMER-LED RECOVERY? 2.5 Contributions to GDP growth, %pt 2.0 2015 2016 2017 1.5 1.0 0.5 0.0-0.5-1.0 Household spending Government spending Investment Net exports GDP 30
COULD UNKNOWN UNKNOWNS DERAIL CONSUMPTION? Unexplained Consumer Confidence 15 10 5 0-5 -10 Sept 11 Iraq Invasion Grexit fears -15 ERM Exit Financial Crisis -20 1986 1990 1994 1998 2002 2006 2010 2014 Dashed lines show one standard deviation 31
SHORT-RUN AVERAGE RELATIONSHIP SUGGESTS NOT Annual consumption growth in quarter t+1 10 R² = 0.011 5 0-15 -10-5 0 5 10 15 Confidence shock in quarter t -5 32
IT TAKES A LOT TO HIT CONSUMER SPENDING Household Consumption (% y/y) 5 4 3 2 1 0-1 -2-3 Average over 4Q Before Shock Average over 4Q After Shock -4-5 ERM Sep-11 Iraq Invasion Financial Crisis Grexit Fears 33
RISKS FROM THE REST OF THE WORLD? Probability 35% Emerging Markets: Rising contagion from China and Fed U.S.: volatility from Fed exit? 30% 25% China: Bumpy transition to consumption-led growth Financial market volatility: 20% Euro Area: Stagnation and entrenched disinflation Europe still not met its challenge of structural reform 15% Middle East / Ukraine: Crisis escalation? Source: IIF Global Economic Monitor, February 2015. 34
POLICY REACTION FUNCTION
FISCAL TIGHTENING TO REMAIN A KEY HEADWIND 5 % of GDP 4 3 2 1 0-1 -2-3 PSNB (2015-16) Debt interest Capital spending Other spending Receipts Welfare Public services spending PSNB (2019-20) Source: OBR 36
PUBLIC SPENDING FALLING TOWARD POST-WAR LOWS AS A SHARE OF OUTPUT % of GDP 65 Current receipts Total managed expenditure 60 55 50 Forecast 45 40 35 30 25 20 1920-21 1930-31 1940-41 1950-51 1960-61 1970-71 1980-81 1990-91 2000-01 2010-11 2020-21 Source: OBR 37
MARKET EXPECTS BANK RATE TO REMAIN AT 0.5% UNTIL 2020, WITH SOME PROBABILITY (50%) OF A RATE CUT Bank Rate % 6.0 5.0 4.0 3.0 2.0 1.0 History Market Expectations 0.0 2008 2010 2012 2014 2016 2018 2020 * Derived from money market futures prices Source: Bloomberg/LBCB 38
RATE EXPECTATIONS PUSHED OUT G4 rate expectations 39
THE NEGATIVE YIELD CLUB IS GROWING fuelling concern about deflation, central banks etc. Japan has joined the club of European countries with negative interest rates, including the Eurozone, Denmark, Sweden and Switzerland. All told, some $7 trillion in government bonds now have negative yields. Source: IIF 40
THE IMPACT OF NEGATIVE RATES: POSITIVE OR NEGATIVE? In principle, cutting policy rates into negative territory should boost growth and inflation. But central banks have not communicated these benefits clearly, raising the risk that negative rates do more harm than good. Although markets are rebounding, the sharp falls in equity prices and in particular bank shares since the beginning of the year have led many to claim that negative rates are damaging global economic prospects. Markets have focused on three main concerns. First, negative deposit rates impose a direct financial cost on banks, harming their profitability and thus their willingness to make new loans. These costs are largest in Switzerland, where the interest rate is most negative and applies to a large share of bank reserves. Even so, these costs do not appear to be huge. We estimate that negative policy rates in the four European economies that have applied them are costing the banking sector around 3bn a year. That is a trivial fraction of their assets and is not a gamechanger for their profitability either. Moreover, central banks can reduce the share of reserves subject to negative rates as the BoJ has promised to do in order to alleviate these concerns. Instead, we suspect the larger problem for banks is the (further) decline in long term rates, which reduces their ability to generate profits from lending. However, the key point here is that the looser monetary policy is now, the sooner the economy should return to health, allowing interest rates to rise. The second fear is that the rush to impose negative policy rates is the latest front in a futile currency war. There is some truth to this argument as a weaker exchange rate is a key channel through which negative rates can operate. But there is little evidence that the major central banks are competing to weaken their currencies, and insofar as they are, the result will be looser global monetary policy which should be positive for global growth. Indeed, negative policy rates appear to have contributed to a reduction in borrowing costs for households and firms, as shown for the euro-zone. Perhaps the biggest worry though is that cuts to policy rates have added to the sense that the world economy is slowing sharply and that policymakers are running out of options. Policy loosening has fuelled, rather than soothed, market fears. Indeed it was striking that global bank stocks sold off sharply, partly in response to the decision by Sweden (share of world GDP: 0.4%) to cut policy rates to -0.5%. Central banks themselves are partly to blame for this response because they have repeatedly claimed that policy rates could not be lowered further, only to surprise the markets by cutting rates weeks later. Nonetheless, claims that monetary policy has reached its limits are exaggerated. After all, there is still plenty of scope for further quantitative easing. Overall, we still think that negative policy rates will prove effective in helping to lift growth and inflation. That said, if the latest market turmoil leads to a sustained tightening in financial conditions, the economic consequences could easily outweigh the benefits of slightly lower policy rates. 41
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