Economics Group Special Commentary Executive Summary Following very weak growth in 2011 and most of 2012, real consumer spending in the United Kingdom has strengthened somewhat in recent quarters. Although growth in real disposable income has been sluggish recently, consumers have been willing to let their savings rates recede in recent quarters, which has financed growth in real spending. Rising consumer confidence and stronger balance sheets have likely made consumers less anxious about the future, which may be reducing their precautionary motive for saving. We forecast that growth in real consumer spending will strengthen further over the next two years, although not back to rates that prevailed during the long economic expansion of 1992 to 2007. Although the personal savings rate has room to trend lower, we believe that growth in real disposable income will remain slow for the foreseeable future. Hiring intentions among British businesses remain subdued, and inflation, which erodes purchasing power, likely will recede, albeit at a slow rate. Consumer Spending Has Driven U.K. GDP Growth Recently In a report we wrote in 2010, we surmised that growth in British consumer spending likely would be sluggish over the next few years. 1 In the event, real personal consumption expenditures (PCE) contracted 0.5 percent in 2011 before growing at a subpar rate of only 1.2 percent in 2012. Although growth in consumer spending over the past few years has been relatively sluggish, at least when measured against the standard of the long 1992 2007 economic expansion when real Figure 1 Figure 2 3% Contributions to U.K. GDP Growth Percent of Growth, Year-over-Year Change 3% 8.5% 8. U.K. Unemployment Rate ILO, Seasonally Adjusted Unemployment Rate: Jul @ 7.7% Jay H. Bryson, Global Economist jay.bryson@wellsfargo.com (704) 410-3274 Mackenzie Miller, Economic Analyst mackenzie.miller@wellsfargo.com (704) 410-3358 Will British Consumers Continue to Spend? 8.5% 8. 7.5% 7.5% 1% 1% 7. 7. 6.5% 6.5% -1% -1% - -3% - -5% Net Exports Government Consumption Inventories BFI Personal Consumption Year-over-Year GDP Growth - -3% - -5% 6. 5.5% 5. 4.5% 1997 1999 2001 2003 2005 2007 2009 2011 2013 6. 5.5% 5. 4.5% 1 See Outlook for U.K. Growth Amid Budget Cutting (Oct. 26, 2010), which is available upon request. This report is available on wellsfargo.com/economics and on Bloomberg WFRE.
British unemployment rate has seen only modest improvement. PCE grew at an average annual rate of 3.6 percent, it has strengthened somewhat in recent quarters. Moreover, real PCE has been the primary driver of overall GDP growth in the United Kingdom over the past year or so (Figure 1). What has propelled growth in British real PCE in recent quarters? What is the outlook for consumer spending and, by extension, the British economy in the quarters ahead? We attempt to answer some of these questions in this report. Decline in Savings Rate Has Helped to Support Consumer Spending Although employment is growing again the number of jobs is up 3.6 percent from its March 2010 low the elevated rate of unemployment manifests the general weakness in the labor market. Since the cycle peak of 8.4 percent in December 2011, the British unemployment rate has seen only modest improvement subsequently (Figure 2). Indeed, the 7.7 percent rate that was recorded in July remained well above rates that prevailed prior to the Global Financial Crisis (GFC). 2 Figure 3 Figure 4 U.K. Consumer Spending Indicators Year-over-Year Growth Rates Real Disposable Income: Q1 @ -0.3% Personal Consumption Expenditures: Q1 @ 1. 1 1 U.K. Personal Savings Rate Percent of Disposable Income, SA Personal Savings Rate: Q2 @ 5.9 1 1 8% 8% - - - - - 01 02 03 04 05 06 07 08 09 10 11 12 13-90 92 94 96 98 00 02 04 06 08 10 12 Consumers financed growth in GDP by allowing their personal savings rates to decline. Due to this weakness in the labor market, wage growth has been slow, resulting in anemic growth in income. On a year-ago basis, nominal disposable income was up only 1.9 percent in Q2 2013. However, because inflation is running at a higher rate than nominal income at present, real disposable income fell 0.7 percent in the second quarter (Figure 3). So, if purchasing power (i.e., real disposable income) is contracting at present, how did British consumers finance the 1.6 percent year-over-year increase in real personal consumption expenditures that occurred in the second quarter? The answer: they allowed their personal savings rate to decline to 5.9 percent in Q2 2013 from 7.4 percent in Q2 2012 (Figure 4). Will growth in real disposable income bounce back, or will consumers need to finance growth in consumer spending by continuing to run down their personal savings rates? The good news on this front is that consumers should get some relief from easing inflationary pressures that, everything else equal, would boost growth in real disposable income. Most forecasters project CPI inflation will recede from the 2.7 percent rate that was registered in August to roughly 2 percent by 2015. 3 On the other hand, however, growth in nominal disposable income likely will remain rather sluggish due to continued weak growth in employment. Survey evidence shows that hiring intentions over the next six months among British businesses, 2 Between Q2 1998 and Q2 2008 the unemployment rate in the United Kingdom averaged 5.3 percent. 3 Our forecast calls for CPI inflation to decline from 2.6 percent this year to 2.1 percent in 2014 before edging up to 2.3 percent in 2015. The consensus forecast, as measured by Focus Economics, looks for 2.7 percent (2013), 2.4 percent (2014) and 2.3 percent (2015). The Bank of England forecasts CPI inflation will recede to 2.0 percent by the end of 2015. 2
although positive, remain weak when compared to the previous expansion (Figure 5). Lackluster growth in employment, should it indeed come to pass, is consistent with the slow decline in the unemployment rate that forecasters project. 4 On balance, it seems that growth in real disposable income will likely remain weak for the foreseeable future. Even if growth in real disposable income remains sluggish, growth in real PCE can remain positive, and even strengthen somewhat, if consumers allow their personal savings rates to recede even further. As Figure 4 makes clear, the personal savings rate trended lower between the early 1990s and the advent of the GFC more than a decade later. One reason why consumers may be willing to save less in coming quarters is that consumer confidence has rebounded significantly in recent months (Figure 6). If consumers are feeling more optimistic, they may perceive less of a need to save for precautionary reasons. Figure 5 Figure 6 3.0 U.K. Employment Intentions Index 3.0 10 U.K. Consumer Confidence Diffusion Index, Seasonally Adjusted 10 Consumers may be willing to save less in coming quarters since consumer confidence has rebounded recently. 2.0 2.0 1.0 1.0 0 0 0.0 0.0-10 -10-1.0-1.0-2.0-2.0-20 -20-3.0-3.0-30 -30-4.0 Total Services: August @ 0.30-4.0 Manufacturing: August @ 0.30-5.0-5.0 1997 1999 2001 2003 2005 2007 2009 2011 2013 Consumer Confidence: Sep @ -1.0-40 2001 2003 2005 2007 2009 2011 2013-40 Balance Sheet Repair Supports Consumer Spending Consumer confidence may be improving because balance sheets are getting stronger again. Not only has the value of financial assets risen by nearly 1 trillion since the GFC, but the value of nonfinancial assets (largely real estate) has trended higher as well (Figure 7). The widely followed index of house prices that is compiled by the Nationwide Building Society shows that house prices in the United Kingdom were up 5.0 percent on a year-ago basis in September. Although the increase in house prices has been led by London, where prices are 8 percent higher than their previous peak, all 13 regions experienced price appreciation on a year-over-year basis in September for the first time since 2007. In that regard, government measures, such as Funding for Lending and Help to Buy, could be helping to lift house prices via lower mortgage rates and more access to credit that helps to spur demand for housing. On the liability side of the balance sheet, households have been deleveraging over the past few years. The household debt-to-disposable income ratio, which peaked at more than 150 percent in 2008, is closing in on 130 percent (Figure 8). The rise in asset values and the decline in liabilities have led to a 1.5 trillion increase in net worth since 2008 (Figure 7). If net worth continues to rise, then it is likely that the personal savings rate will continue to trend lower, which would support growth in real PCE. 4 The consensus forecast expects the unemployment rate to average 7.6 percent next year and 7.4 percent in 2015. The Bank of England does not believe that the unemployment rate will fall below 7 percent until 2016. 3
Figure 7 Figure 8 12 10 8 Balance Sheets of U.K. Households Trillions of Pound Sterling Total financial assets Total non-financial assets Total financial liabilities Total net worth 12 10 8 17 16 15 14 U.K. Household & Nonprofit Debt As a Share of Gross Disposable Income Household Debt/Disposable Income: Q1 @ 132. 17 16 15 14 6 6 13 13 4 4 12 12 2 2 11 10 11 10 0 0 9 9-2 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012-2 8 1998 2000 2002 2004 2006 2008 2010 2012 8 Source: U.K. Office for National Statistics, IHS Global Insight and Wells Fargo Securities, LLC Whither British Consumer Spending? Between Q4 2007 and Q2 2009, real PCE tanked 6.5 percent, which was a major reason behind the 7.2 percent peak-to-trough nosedive in British real GDP during the downturn. Although real PCE has trended higher over the past four years, the level in Q2 2013 remained 3.0 percent below its prerecession peak. Growth in consumer spending has been slowed by overall slow growth in the British economy, which has restrained employment growth and, correspondingly, income growth. In addition, deleveraging among households over the past five years has also exerted headwinds on real PCE growth. Consumer spending in the United Kingdom may be starting to thaw. The rise in asset prices that has occurred over the past few years has helped consumers repair their battered balance sheets. The rise in asset prices arguably has played an important role in the sharp increase in consumer confidence as well. With consumers feeling less anxious, they have allowed their savings rates to recede somewhat in recent quarters to help finance growth in spending. There is room for the personal savings rate to trend lower in coming quarters, which would help support continued growth in real PCE. However, robust growth in consumer spending likely would require marked acceleration in real disposable income, which we do not think is in the cards, at least not in the foreseeable future. For starters, CPI inflation remains elevated, which helps to erode growth in real disposable income. Although inflation should gradually recede, a sharp decline, which would significantly boost growth in real income, does not seem likely. In addition, recent surveys suggest that the pace of employment growth likely will remain muted in coming quarters, which will restrain growth in nominal income. We project that real PCE will grow 1.6 percent in 2013, which, if realized would be the fastest pace of growth since 2007. We look for real PCE growth to strengthen to 1.9 percent in 2014 and 2.3 percent in 2015. Although certainly an improvement when compared to the average annual growth rate of only 0.6 percent during 2010 2012, growth in real PCE would remain well short of the 3.6 percent rate that was the norm during the long expansion of 1992 2007. With real PCE accounting for more than 60 percent of overall GDP in the United Kingdom, subpar growth in real PCE likely will translate into continued slow growth in real GDP. Indeed, the 2.4 percent growth rates in real GDP in both 2014 and 2015 that we forecast would be nearly a full percentage point below the annual average growth rate between 1992 and 2007. 4
Wells Fargo Securities, LLC Economics Group Diane Schumaker-Krieg Global Head of Research, Economics & Strategy (704) 410-1801 (212) 214-5070 diane.schumaker@wellsfargo.com John E. Silvia, Ph.D. Chief Economist (704) 410-3275 john.silvia@wellsfargo.com Mark Vitner Senior Economist (704) 410-3277 mark.vitner@wellsfargo.com Jay H. Bryson, Ph.D. Global Economist (704) 410-3274 jay.bryson@wellsfargo.com Sam Bullard Senior Economist (704) 410-3280 sam.bullard@wellsfargo.com Nick Bennenbroek Currency Strategist (212) 214-5636 nicholas.bennenbroek@wellsfargo.com Eugenio J. Alemán, Ph.D. Senior Economist (704) 410-3273 eugenio.j.aleman@wellsfargo.com Anika R. Khan Senior Economist (704) 410-3271 anika.khan@wellsfargo.com Azhar Iqbal Econometrician (704) 410-3270 azhar.iqbal@wellsfargo.com Tim Quinlan Economist (704) 410-3283 tim.quinlan@wellsfargo.com Michael A. Brown Economist (704) 410-3278 michael.a.brown@wellsfargo.com Sarah Watt Economist (704) 410-3282 sarah.watt@wellsfargo.com Michael T. Wolf Economist (704) 410-3286 michael.t.wolf@wellsfargo.com Sara Silverman Economic Analyst (704) 410-3281 sara.silverman@wellsfargo.com Zachary Griffiths Economic Analyst (704) 410-3284 zachary.griffiths@wellsfargo.com Mackenzie Miller Economic Analyst (704) 410-3358 mackenzie.miller@wellsfargo.com Blaire Zachary Economic Analyst (704) 410-3359 blaire.a.zachary@wellsfargo.com Peg Gavin Executive Assistant (704) 410-3279 peg.gavin@wellsfargo.com Cyndi Burris Senior Admin. Assistant (704) 410-3272 cyndi.burris@wellsfargo.com Wells Fargo Securities Economics Group publications are produced by Wells Fargo Securities, LLC, a U.S broker-dealer registered with the U.S. Securities and Exchange Commission, the Financial Industry Regulatory Authority, and the Securities Investor Protection Corp. Wells Fargo Securities, LLC, distributes these publications directly and through subsidiaries including, but not limited to, Wells Fargo & Company, Wells Fargo Bank N.A., Wells Fargo Advisors, LLC, Wells Fargo Securities International Limited, Wells Fargo Securities Asia Limited and Wells Fargo Securities (Japan) Co. Limited. Wells Fargo Securities, LLC. ("WFS") is registered with the Commodities Futures Trading Commission as a futures commission merchant and is a member in good standing of the National Futures Association. Wells Fargo Bank, N.A. ("WFBNA") is registered with the Commodities Futures Trading Commission as a swap dealer and is a member in good standing of the National Futures Association. WFS and WFBNA are generally engaged in the trading of futures and derivative products, any of which may be discussed within this publication. The information and opinions herein are for general information use only. Wells Fargo Securities, LLC does not guarantee their accuracy or completeness, nor does Wells Fargo Securities, LLC assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, are for general information only and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. Wells Fargo Securities, LLC is a separate legal entity and distinct from affiliated banks and is a wholly owned subsidiary of Wells Fargo & Company 2013 Wells Fargo Securities, LLC. Important Information for Non-U.S. Recipients For recipients in the EEA, this report is distributed by Wells Fargo Securities International Limited ("WFSIL"). WFSIL is a U.K. incorporated investment firm authorized and regulated by the Financial Services Authority. The content of this report has been approved by WFSIL a regulated person under the Act. WFSIL does not deal with retail clients as defined in the Markets in Financial Instruments Directive 2007. The FSA rules made under the Financial Services and Markets Act 2000 for the protection of retail clients will therefore not apply, not will the Financial Services Compensation Scheme be available. This report is not intended for, and should not be relied upon by, retail clients. This document and any other materials accompanying this document (collectively, the "Materials") are provided for general informational purposes only. SECURITIES: NOT FDIC-INSURED/NOT BANK-GUARANTEED/MAY LOSE VALUE