Economic Outlook

1
Economic Outlook

• John Hawksworth
• Head of Macroeconomics
• June 2005

PwC
2
Agenda

• Global context
• UK economic trends and prospects
• Public finances
• Summary

3
The global economy recorded significantly above
trend growth in 2004, but is now slowing again
Long-run average
Forecasts
Note using GDP at market exchange rates as
weights
4
Recovery in global equity markets has also
tapered off recently
5
Global economy reasons for optimism

• The US economy remains relatively strong
• Most Asian emerging market economies have
  significant upward momentum
• Fears of overheating in China have receded
  somewhat

6
Global economy reasons for caution

• US twin trade and budget deficits, and high debt
  levels
• Further falls in the dollar could undermine the
  fragile export-led recovery in Euroland
• Renewed weakness in Japan could impact on other
  Asia-Pacific economies
• High and volatile oil prices

7
UK economic trends and prospects
8
UK GDP growth slowed in the first quarter of 2005
9
UK growth remains unbalanced across sectors
real output growth (year to Q1 2005)
10
The industrial sector has sunk back into recession
11
Will China eat our lunch?

• Economic theory says no
• different countries should specialise in areas of
  comparative advantage low labour cost
  manufacturing in the case of China high value
  added services for UK
• as Chinese economy develops, wages will rise with
  productivity (though this may take a long time
  given scale of excess labour to be absorbed from
  rural areas)
• Practical reality may be less sanguine
• Chinese (and other Asian) firms moving rapidly up
  the technological ladder
• UK economy needs to be very flexible to respond

12
Purchasing managers index of business activity
suggests widening slowdown
13
But financial services sector more optimistic
14
Domestic demand has been the main driver of UK
growth, but is slowing down
15
Weakness of UK net exports in recent years
reflects continued strength of sterling
Stronger Pound
dollars per
euros per
16
There has been a significant moderation in the
growth of UK retail sales recently
17
reflecting the housing market slowdown since
last summer
18
UK CPI Inflation has risen towards target in
recent months
Bank of England target
19
But short-term interest rates are likely to be at
or close to their peak in current cycle
20
Grounds for cautious optimism

• Unemployment at historically low levels
  employment rising
• Low inflation and interest rates
• House prices appear to be slowing gradually
  soft landing?
• Government spending still rising rapidly in
  2005/6
• Corporate balance sheets reasonably healthy
  should boost business investment
• Global economy and stock markets still reasonably
  strong despite recent slowdown

21
Risk factors

• Oil prices high and likely to remain so in 2005
• Concern about sustainability of US current and
  budget deficits may push dollar lower
• dampening both UK manufacturing and UK export
  markets
• High UK household debt levels
• what happens if house prices fall faster than
  expected?
• Weak consumer spending
• Rising budget deficit reduces scope for future
  public spending growth and leads to concerns
  about future tax rises

22
Alternative GDP growth scenarios
Source NS, PricewaterhouseCoopers
23
Outlook for the public finances
24
Government faces additional spending pressures
beyond 2007/8

• NHS Wanless report recommended rise of c.1.2 of
  GDP between 2007/8 and 2012/13
• Public services pensions Treasury predicts
  spending will rise from 0.5 of GDP in 2002/3 to
  0.8 by 2013/14
• International aid pledged to rise from 0.4 of
  GDP now to 0.7 of GDP by 2013
• Childcare ten year strategy implies rising trend
  as GDP
• Overall if these plans are carried out, total
  public spending could rise from 42.4 of GDP in
  2007/8 to 44 by 2013/14
• But will this be affordable?

25
Public borrowing Treasury forecasts vs PwC main
scenario projections
26
Implications for tax and spending

• Treasury revenue forecasts look optimistic in
  medium term
• we expect slower rebound in corporate tax
  receipts
• slower consumer spending growth will hit VAT
  receipts
• A decision is likely in the 2006 Budget
• If revenues are undershooting HMT forecasts, then
  taxes will have to be increased or current
  spending growth slowed
• non-priority spending areas likely to be tightly
  squeezed
• The economic and fiscal outlook remains
  uncertain, but tough choices look unavoidable

27
Summary of UK economic outlook

• UK growth seems to be decelerating
• c.3.1 in 2004
• c.2.5 in 2005 and 2006 (with risks weighted to
  downside)
• Reflects global slowdown in 2005, as well as
  recent weakness of consumer spending and the
  prospect of future tax increases
• But public sector and business and financial
  services still growing relatively strongly
• Conclusion UK economy slowing but no serious
  risk of recession given scope to cut interest
  rates if necessary