Download The economic outlook

The Green Budget
The Economic Outlook
January 2006
Professor David Miles +44 20 7425 1820 [email protected]
Melanie Baker +44 20 7425 8607 [email protected]
Vladimir Pillonca +44 20 7425 5839 [email protected]
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that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as
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The Economic Outlook

Economic growth has been relatively robust over the past few
years, although it slowed substantially in 2005. The Treasury
expects the economy to pick up, with growth of between 2¾% and
3¼% by 2007 and the output gap closing in 2008–09.

There are downside risks to the Treasury’s forecasts in the medium
term, from a slowdown in productivity growth, inadequate saving
and a large and persistent current account deficit.

We do not expect growth to accelerate significantly over the next
two to three years. Growth could be slower still if inflationary
pressures force the Bank of England to raise interest rates.

Our analysis suggests that there is little spare capacity in the
economy. The Treasury identifies longer cycles than we do: it
believes that only three have been completed since 1972, whereas
we identify five to six.
Please refer to important disclosures at the end of this presentation
Treasury’s projection of real GDP (% change
terms)
Percentage change in real GDP
4.0
Treasury's projection
(centre point)
3.5
one
standard
deviation
band
3.0
2.5
2.0
1.5
1.0
2001
2002
2003
2004
2005e
2006e
2007e
2008e
Note: We assume that the Treasury’s forecast errors follow a normal distribution with mean zero and
variance σ2. The absolute forecast error then follows a half-normal distribution with a mean equal to √(2/π)
multiplied by σ. Since we know that the Treasury’s mean forecast error is 0.5, we can deduce that σ=0.63
(and σ2=0.39). Using this, we can use the properties of the normal distribution to tell us the probability of the
forecast error lying in a given range. The probabilities given in the text may well be somewhat
underestimated. This is because the Treasury gives the mean forecast error for the ‘current year and year
ahead projections made in autumn forecasts’, when it would already have a significant amount of information
to forecast the current year’s GDP growth. We also assume forecast errors are uncorrelated across periods.
Sources: HM Treasury; ONS; Morgan Stanley Research.
Please refer to important disclosures at the end of this presentation
Tentative evidence of rebalancing away from the
consumer
Household consumption (real, four quarters on
previous four quarters)
Fixed investment (real, four quarters on previous
four quarters)
15
10
5
0
-5
Q1 2005
Q1 2004
Q1 2003
Q1 2002
Q1 2001
Q1 2000
Q1 1999
Q1 1998
Q1 1997
Q1 1996
Q1 1995
Q1 1994
Q1 1993
Q1 1992
Q1 1991
Q1 1990
Q1 1989
Q1 1988
Q1 1987
-10
Q1 1986
Percentage change
20
Source: ONS
Please refer to important disclosures at the end of this presentation
25
Household balance sheets: total financial assets
20
Household balance sheets: total financial liabilities
15
10
5
0
-5
-10
Q1 2006
Q1 2005
Q1 2004
Q1 2003
Q1 2002
Q1 2001
Q1 2000
Q1 1999
Q1 1998
-15
Q1 1997
Percentage change year-on-year
Balance sheet repair: slower debt, faster asset
accumulation
Source: ONS
Please refer to important disclosures at the end of this presentation
15.0
Profitability: UK non-continental shelf private non-financial
corporates
14.5
14.0
13.5
13.0
12.5
12.0
11.5
Q1 2006
Q1 2005
Q1 2004
Q1 2003
Q1 2002
Q1 2001
Q1 2000
Q1 1999
Q1 1998
11.0
Q1 1997
Corporate rate of return: ratio of operating
surplus to capital employed (%), net of
depreciation
Profitability strong, despite slowdown in growth
Source: ONS
Please refer to important disclosures at the end of this presentation
Medium term Risks: The Productivity and Growth
Outlook

Saving is low

Productivity has slowed

Much of the slowdown appears to be cyclical.

But a substantial part is structural and that is worrying.
Please refer to important disclosures at the end of this presentation
Gross national saving as % of GDP
UK gross national saving rate low compared with
other economies
40
35
30
25
20
15
10
5
France
Germany
Italy
Japan
United Kingdom
United States
0
1980
1984
1988
1992
1996
2000
2004
Source: IMF World Economic Outlook database, September 2005
Please refer to important disclosures at the end of this presentation
Whole economy gross fixed capital formation
less consumption of fixed capital (% of GDP)
Net investment not high enough to sustain 2½%
GDP growth
12
Net investment as % of GDP
10
8
6
4
2
0
1970
1974
1978
1982
1986
1990
1994
1998
2002
Source: ONS and Morgan Stanley Research
Please refer to important disclosures at the end of this presentation
Saving rate looks too low to sustain 2½% GDP
growth
12
National net saving rate
10
Household saving ratio
6
4
2
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
0
1987
%
8
Source: ONS and Morgan Stanley Research
Please refer to important disclosures at the end of this presentation
Real GDP per hour worked (UK=100)
France
Germany
USA
UK
Japan
1990
131
n/a
130
100
93
1995
137
126
120
100
90
2000
134
121
117
100
86
2003
129
115
112
100
82
2004
129
112
114
100
83
Note: Data for 2004 are provisional and subject to revision.
Source: ONS, experimental internationally comparable series
Please refer to important disclosures at the end of this presentation
Real GDP per worker (UK=100)
France
Germany
USA
UK
Japan
1990
131
n/a
137
100
107
1995
123
111
130
100
97
2000
118
104
128
100
92
2003
110
99
122
100
88
2004
111
97
124
100
89
Note: Data for 2004 are provisional and subject to revision.
Source: ONS, experimental internationally comparable series.
Please refer to important disclosures at the end of this presentation
Labour productivity growth has slowed sharply
6
2
Q1 2002
Q1 1999
Q1 1996
Q1 1993
Q1 1990
Average (1978 - 2005Q3)
Q1 1987
-4
Q1 1984
Output per filled job - whole economy
Q1 1981
-2
Q1 2005
0
Q1 1978
Annual % growth
4
Sources: ONS and Morgan Stanley Research
Please refer to important disclosures at the end of this presentation
Decomposing GDP per-capita growth – the UK
experience
Factors:
Capital
deepening
Participation
rate
Employment
rate
Hours
worked
TFP
growth
trend
Cyclical
component of
TFP growth
GDP
growth
per
capita
1972–2004
0.70
0.18
–0.01
–0.19
1.41
0.04
2.13
1972–1984
0.70
0.34
–0.42
–0.26
1.36
0.03
1.76
1985–1995
0.48
–0.02
0.21
–0.08
1.59
0.10
2.29
1996–2004
0.98
0.19
0.31
–0.25
1.28
0.02
2.52
2001
1.45
–0.01
0.22
–0.18
1.57
–1.22
1.82
2002
0.78
0.36
–0.05
–0.57
1.42
–0.32
1.62
2003
0.38
0.31
0.11
–0.40
1.57
0.13
2.10
2004
0.20
0.16
0.18
–0.19
1.34
1.07
2.75
2005 Q3
0.42
0.54
–0.18
0.07
1.08
–0.84
1.09
Note: The trend rate of TFP growth is calculated with a Christiano-Fitzgerald Band Pass Filter, which aims to decompose output into a
permanent (‘trend’) component and a cyclical factor.
Source: Morgan Stanley Research.
Please refer to important disclosures at the end of this presentation
Medium term Risks: The Current Account and
Balance of payments

Trade and current account deficits have been rising

This is a reflection of low saving and an exchange rate that
makes it tough for producers of traded goods to compete.

All this has generated a decline in net overseas assets

Potential for exchange rate – and terms of trade - adjustment
to be substantial
Please refer to important disclosures at the end of this presentation
UK continues to run a significant trade and current
account deficit
1
0
% of GDP
-1
-2
-3
-4
-5
Goods trade deficit
Trade deficit: goods and services
Current account deficit
-6
1993 1994 1995
1996 1997 1998
1999 2000 2001 2002 2003
2004
Sources: ONS; Morgan Stanley Research
Please refer to important disclosures at the end of this presentation
Q4 1977
Q4 1978
Q4 1979
Q4 1980
Q4 1981
Q41982
Q4 1983
Q4 1984
Q4 1985
Q4 1986
Q4 1987
Q4 1988
Q4 1989
Q4 1990
Q4 1991
Q4 1992
Q4 1993
Q4 1994
Q4 1995
Q4 1996
Q4 1997
Q4 1998
Q4 1999
Q4 2000
Q4 2001
Q4 2002
Q4 2003
Q4 2004
Total external assets less total external liabilities
Net UK overseas liabilities (% of GDP)
30
25
20
15
10
5
0
-5
-10
-15
-20
-25
Net international investment position (% of GDP)
Sources: ONS; Morgan Stanley Research
Please refer to important disclosures at the end of this presentation
The Treasury’s
projections
and the economic cycle
Please refer to important disclosures at the end of this presentation
Estimates of potential output growth
(% annual change)
2004–05 2005–06E 2006–07E 2007–08E 2008–09E 2009–10E 2010–11E
Morgan Stanley central case
2.35
2.30
2.30
2.30
2.29
2.37
2.42
Treasury estimates
2.75
2.75
2.69
2.50
2.50
2.50
2.50
Note: The above estimates are based on statistical filters which separate the level of output into a trend ‘underlying’ component
and a cyclical component. The cyclical component is zero on average over long-enough periods, and tends to reflect temporary
deviations from the underlying trend.
Sources: Morgan Stanley Research; HM Treasury.
Please refer to important disclosures at the end of this presentation
Business cycles have become less marked, making
the dating of the cycle harder
Forecast
5
%
3
1
-1
-3
Q2 2007
Q1 2002
Q4 1996
Q3 1991
Q2 1986
Q4 1975
Q3 1970
Q2 1965
Q1 1960
-5
Q1 1981
HP filter (lambda=1600)
Christiano-Fitzgerald band-pass filter
Baxter-King band-pass filter
Source: Morgan Stanley Research
Please refer to important disclosures at the end of this presentation
The Treasury has shifted the date of the current
cycle back to 1997 and it now predicts that it will
last until the end of 2008
3
HM Treasury
HP filter (lambda=1600)
CF band-pass filter
% of potential output
2
1
0
-1
-2
-3
-4
1990Q1
1992Q3
1995Q1
1997Q3
2000Q1
2002Q3
2005Q1
2007Q3
Source: Morgan Stanley Research; HM Treasury
Please refer to important disclosures at the end of this presentation
Dates of UK economic cycles
HM Treasury
HP 1600
CF
BK
1972Q4 – 1978Q1
1972Q4 – 1977Q3
1972Q3 – 1977Q4
1972Q3 – 1977Q3
1978Q1 – 1986Q2
1977Q4 – 1987Q2
1978Q1 – 1982Q4
1977Q4 – 1987Q1
1986Q2 –1997Q2
1987Q3 – 1994Q1
1983Q1 – 1987Q4
1987Q2 – 1994Q1
1997Q2 – F2008Q4
1994Q2 – 1999Q3
1988Q1 – 1993Q3
1994Q2 – 1999Q3
1999Q4 – 2003Q3
1993Q4 – 1999Q4
1999Q4 – 2003Q3
2003Q4 – F2007Q2
2000Q1 – 2003Q2
2003Q4 –
2003Q3 – F2007Q2
Source: Morgan Stanley Research; HM Treasury
Please refer to important disclosures at the end of this presentation
The Morgan Stanley
forecasts
Please refer to important disclosures at the end of this presentation
GDP growth forecast
3.20
3.00
Real GDP, percent
change year-onyear
2.80
2.60
2.40
2.20
2.00
1.80
Morgan Stanley central case
1.60
Morgan Stanley 'worse case'
Treasury forecasts (PBR 2005)
1.40
2004-05
2005-06
2006-07
2007-08
2008-09
2009-10
2010-11
Please refer to important disclosures at the end of this presentation
Morgan Stanley central case economic projections
2004– 2005– 2006– 2007– 2008– 2009– 2010–
05
06E
07E
08E
09E
10E
11E
Real GDP
(% annual change)
2¾
1¾
2½
2¾
2¼
2½
2½
Real consumer spending
(% annual change)
3½
1½
2
2¼
2
2¼
2¼
Employment
(% annual change)
1
1
¾
¾
½
¾
½
CPI inflation
(% annual change)
1½
2¼
2
2
2¼
2
2
Output gap
(%)
0.3
–0.3
–0.2
0.1
–0.1
0
0.1
Saving rate
(%)
4¼
5½
5½
5¾
6
5¾
5½
Unemployment rate
(%)
4¾
4¾
5
5
5
5¼
5¼
Productivity growth
(% annual change)
1¾
1
1¾
2
1¾
1¾
1¾
E = Morgan Stanley Research estimates.
Sources: ONS; Morgan Stanley Research.
Please refer to important disclosures at the end of this presentation
Morgan Stanley ‘worse case’ economic projections
2004– 2005– 2006– 2007– 2008– 2009– 2010–
05
06E
07E
08E
09E
10E
11E
Real GDP
(% annual change)
2¾
1¾
1½
2
2
2½
2½
Real consumer spending
(% annual change)
3½
1½
¾
1½
1½
2½
2½
Employment
(% annual change)
1
1
½
½
½
¾
1
CPI inflation
(% annual change)
1½
2¼
2¾
2½
2½
2
2
Output gap
(%)
0.4
–0.1
–0.2
–0.2
–0.2
–0.1
0.1
Saving rate
(%)
4¼
5½
6¼
6
6
6
5¾
Unemployment rate
(%)
4¾
4¾
5¼
5½
5½
5½
5½
Productivity growth
(% annual change)
1¾
¾
1¼
1½
1½
1½
1½
E = Morgan Stanley Research estimates.
Sources: ONS; Morgan Stanley Research.
Please refer to important disclosures at the end of this presentation
Disclaimer
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