Prospects for the UK economy.

Kirby, Simon ; Whitworth, Rachel

The production of this forecast is supported by the Institute's Corporate Members: Bank of England, HM Treasury, the Office for National Statistics, Santander (UK) plc and by the members of the NiGEM users group.

Introduction

The persistent weakness of UK economic growth figures has dominated recent economic commentary. This debate continued with the release of the Office for National Statistics' (ONS) preliminary estimate of GDP growth for the second quarter of this year. The ONS estimates that the economy enjoyed only a modest expansion in the second quarter: 0.2 per cent per quarter. This implies the level of output is little changed from the third quarter of 2010. 'One-off effects' are partly responsible for the weak growth in the second quarter. (1) We expect GDP growth to accelerate in the third quarter of this year (see figure 1), but this increase is likely to be flattered by the events of the second quarter.

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Overall we expect the UK economy to expand by 1.3 per cent this year, with growth rising to 2 per cent per annum in 2012. (2) The definition of a recovery is a period of economic expansion above the trend rate of growth. Our current estimate of the trend rate of growth is 2.1 per cent. Given this, the period since the end of the recession (from the final quarter of 2009 onwards) cannot be classified as a recovery. (3) Rather it is only in 2013 that we expect economic growth to be above the trend rate.

There is much emphasis, quite rightly, on the effect of the government's consolidation plan. Our estimates suggest that UK economic growth this year would be around 0.8 percentage points higher in the absence of any fiscal tightening. But we must be clear; there are other contributory factors to the weakness of economic growth. The sharp rise in commodity prices will have depressed growth. In addition the private sector is also in the midst of a balance sheet adjustment. In contrast to the public sector, both household and corporate sectors are currently net lenders and actually reducing the scale of their debt holdings (see figure 2). The debt to income ratio of households reached a peak of 1.57 in 2008 and has decreased almost continuously since then. In the first quarter of 2011 the ratio had reached 1.48 (see figure 2). The reduction in debt holdings by the household sector is one of the factors depressing consumer spending, alongside falling real incomes and house prices. The process of balance sheet adjustment will take some time, inhibiting growth for a number of years. We expect the debt to income ratio to continue to fall over the next five years, reaching 1.34 at the end of 2015, but even this is high by historical standards; this would still leave the ratio higher than at any time prior to the third quarter of 2003. The balance sheet adjustment of the household sector could happen much more quickly than we project, which poses a significant downside risk to our GDP forecast and vice versa.

Reductions in the scale of debt holdings will increase the resilience of the household and non-financial corporate sectors to any future interest rate shocks. However, it will take a significant period of sustained debt reduction in order for the household sector to become less susceptible to any interest rate shock. At the current juncture any increase in interest rates would significantly depress real incomes and aggregate demand. Simulations using our global econometric model, NiGEM, suggest that, if the future path of interest rates were 50 basis points higher this year and next, real incomes would contract by an additional 0.1 per cent in 2011 and the growth rate of real disposable incomes in 2012 would be around 0.3 percentage point lower. GDP growth would be reduced by around 0.1 percentage point in both 2011 and 2012.

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But this could underestimate the effect of any interest rate shock to the UK economy at the current juncture. The Bank of England, in its latest Financial Stability Report, suggests that forbearance (the easing or renegotiation of the terms of a loan) has played a significant part in limiting the rise in mortgages in arrears as compared to previous recessionary periods. The increased use of forbearance could mean that the UK banking sector's capital is more at risk than is currently estimated, especially if banks have not introduced enough provisions in light of their forbearance activity. (4)

Given significant risks associated with future economic growth, coupled with the uncertain effects of any monetary tightening through indirect channels such as the impact on loans currently in forbearance, it is perhaps unsurprising that members of the MPC have emphasised that evidence of relatively robust growth in the UK economy is a prerequisite for a rise in interest rates. The short end of the yield curve has flattened since our April forecast (see figure 3). As figure 3 shows, financial markets currently expect the MPC to introduce the first interest rate rise in June 2012, whereas in our April forecast the rise was expected at the end of the third quarter of 2011. Such developments would appear to reflect market perceptions of continued economic weakness.

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The rate of CPI inflation moderated in the second quarter of this year. However, given announcements by domestic energy suppliers (to date: Scottish Power and British Gas), it is likely that the rate of inflation will rise quite sharply over the next couple of months. But such movements are likely to be temporary. Once the effect of the sharp rise in commodity prices and the increase in VAT have passed through to consumers the rate of CPI inflation is expected to fall back towards target (see figure 4). (5) We expect this to happen in the first half of 2012, when the rate of inflation is projected to fall back below the target rate of 2 per cent per annum. Such movements in relative prices are predicated on the presence of a significant amount of spare capacity in the economy. Any estimate of current spare capacity in the economy is intertwined with estimates of the permanent loss of output. Our current estimates suggest that there has been approximately a 4 per cent loss of output as a consequence of the financial crisis and that the output gap is currently around 4 per cent. (6) An underestimate of the permanent loss of output implies an overestimation of the amount of spare capacity in the economy. Similarly, an overestimate of the trend rate of growth implies an underestimate of the speed at which the output gap is closed in our forecast, and vice versa. In both these scenarios the downward pressure on inflation will be less than currently projected.

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Implicit within our forecast is the assumption that the credibility of UK monetary policy is maintained. As noted in Box A on page F43 of the April Review, any drift in the anchor on inflation expectations would require a more aggressive monetary policy response in the face of any further inflationary shocks. As figure A1 in the Appendix shows, the household survey evidence does not suggest inflation expectations have continued to rise. Labour market data do not suggest that we should be concerned about any increase in inflation expectations having an upward pressure on the wage bargain. The latest Average Weekly Earnings statistics show that the annual rate of growth in the three months to May (figure A2) was around 2 per cent in both the public and private sectors, less than half the rate of consumer price inflation. However, this scenario will not persist indefinitely. In particular, we remain concerned about the possibility of this sustained period of loose monetary policy inflating asset prices beyond levels determined by economic fundamentals. Any further expansion of the Bank's Asset Purchase Facility (APF) would certainly add to these concerns. However, if final demand were to be materially weaker, and there was no fiscal policy response beyond allowing the automatic stabilisers to operate freely, then the MPC would probably have little alternative but to request permission from the Chancellor for a further round of Quantitative Easing. In such a scenario an expansion of the Bank's balance sheet should focus on corporate rather than government bonds. As simulations in Barrell and Holland (2010) show, the Federal Reserve was probably able to stimulate the US economy more, with less of an expansion of the Fed's balance sheet, through the use of credit easing, in contrast to the Bank's almost exclusive focus on gilt purchases. (7)

Our forecast continues to imply that the Chancellor will miss the primary target of the Fiscal Mandate of balancing the cyclically adjusted current budget balance by around 1 per cent of GDP. (8) However, this does not mean additional fiscal tightening would be appropriate, at least in the short run. Indeed, it remains our view that in the short term fiscal policy is too tight, and a modest loosening would improve prospects for output and employment, with little or no negative effect on fiscal contribution. Plans to move the UK's public finances onto a sustainable footing in the medium term should not preclude the use of policy to minimise the output gap in the short term. Moreover, because of hysteresis effects, a short-term rise in unemployment also has long-run implications. (9) Indeed, part of the permanent loss of output due to the financial crisis in the UK is due to a permanent rise in the equilibrium unemployment rate.

The publication of the OBR's Fiscal Sustainability Report is a welcome addition to the debate on the long-term sustainability of the UK's public finances. The report highlights, besides the uncertainties associated with such long-run projections, that additional fiscal tightening will be needed in future decades given the likely spending commitments due to an ageing population and increased life expectancy. The government has committed itself to public sector pension reform as proposed by the Hutton Report. However, as the OBR shows, the cost of funding future public sector pension provision will in fact fall as a share of GDP, suggesting that public sector pensions are not a major threat to long-term fiscal sustainability. The large-scale liabilities faced by the UK (and most other advanced economies) are the funding demands from the state pension and the provision of health and social care. The OBR analysis suggests that a 1.5 per cent of GDP fiscal tightening in 2016-17 is required after the end of the current parliament in order to return public sector net debt to 40 per cent of GDP by 2060-61. (10) If we are to prepare for the next crisis and be fair to our children and future generations a more aggressive tightening of policy may be required. The government is currently committing to an approach that might address much of this issue: the automatic uprating of the state pension age. As Barrell et al. (2011) show, a one year increase in working lives (2/3 of a year in effective working lives) would improve the budget balance by around 0.6 per cent of GDP six years after implementation.

There are clearly significant risks to the UK economy in addition to the current headwinds of domestic balance sheet adjustments and continued recession in significant trading partners. At the current juncture the risks would appear to be weighted to the downside. The most obvious risk is a further deterioration in the sovereign debt crisis gripping the Euro Area.

As shown in Holland, Kirby and Orazgani in this Review, the UK has only a small direct exposure to Greek government bonds. Furthermore, the Bank of England's latest Financial Stability Report shows that UK banks have a very limited direct exposure to Greece overall, with lending to the Greek public sector or private sector equal to or less than 10 per cent of Core Tier 1 capital of any UK bank. But this report also highlights the risk of contagion. The median exposure of UK banks to Irish non-bank private sectors is equal to around 20 per cent of Core Tier 1 capital. However, as the Bank of England shows, some banks have exposures equal to almost 70 per cent of Core Tier 1 capital. Clearly a default on Irish government debt could have severe implications for the UK economy.

Prices and earnings

The rate of consumer price inflation in the UK has remained elevated, reflecting the impact of sharp rises in commodity prices, in particular the sharp rise in the price of crude oil throughout 2010 and 2011. The annual rate of CPI inflation has been more than 1 percentage point above the target rate of 2 per cent since the start of 2010. Over the past six months the deviation in the actual rate of inflation from target has been in excess of 2 percentage points. However, inflation figures for the second quarter of this year were lower than we expected at the time of our April forecast; the latest figures suggest CPI inflation fell to 4.2 per cent per annum in June 2011, down 0.3 percentage points from the rate in May. This may be a sign of recent inflationary pressures easing in the coming months, but the ONS notes that downward pressure is due, in part, to summer sales beginning earlier than normal this year.

Recent events in oil markets do support the view of easing inflationary pressures. Oil prices have fallen throughout May and June and, although they have been particularly volatile over this period, the Brent crude oil price is around 7.5 per cent below its peak seen in April. Consequently, our forecast for the world oil price in the short term has been revised downwards. Simulations using our global econometric model, NiGEM, suggest that, in isolation, a reduction in oil price expectations of the magnitude observed since April would reduce CPI inflation by 0.2 percentage points, on average, this year and next. But there are some near-term inflationary pressures, not least the announcement by energy suppliers that they will increase domestic energy prices from the third quarter of this year. Figure 4 plots our forecast for CPI inflation on a quarterly basis. We expect the rate of CPI inflation to rise to an average of 4.4 per cent in the third quarter of 2011, before dipping below 4 per cent by the end of this year, and falling back towards target in the second quarter of 2012. Deviations in the oil price from our assumed path pose both upside and downside risks to our inflation forecast in the short term.

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Figure 5 plots the output price inflation rates for the manufacturing and service sectors. The annual rate of output price inflation of the manufacturing sector rose to 5.3 per cent in the first quarter of this year, from 4.1 per cent in the fourth quarter of 2010. Much of the upward pressure came from petroleum and food products. In contrast the rate of output price inflation from the service sector has been relatively stable, at around 2 1/2 per cent per annum. The manufacturing sector is to a large extent externally focused, while the services sector is predominantly domestically focused. Given this, the relative stability of price rises from the service sector is probably a welcome development for the MPC. Any acceleration in service sector output price inflation would likely feed into higher consumer price inflation.

Import prices have surged over the first half of 2011 partly due to increased prices of commodity imports, including crude oil. This surge was not reflected in export prices however, but export price growth has nevertheless remained robust over the past year. Oil price developments explain much of the robust growth in trade prices in the first half of this year, as was the case in 2008 (see figure 6). ONS figures suggest that, if oil is excluded from trade price calculations, this rate of inflation is halved. We expect import prices to rise by 6.7 per cent in 2011 and we expect the rate of export price inflation to be notably less, at around 3.7 per cent per annum. The depreciation of sterling from the end of

2007 allowed exporters to boost their profit margins. But we expect the potential price competitiveness gains to begin to feed through into the pricing decisions of exporters. This would allow the loss in price competitiveness in 2010 and 2011 to be recovered in 2012 (see table A4). Beyond 2012 we expect both export and import price growth to stabilise at rates in the region of 1 1/2 per cent per annum.

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Wage inflation also appears to have largely stabilised. Public and private sector wage growth rates, as measured by average weekly earnings, have converged since mid-2010 following a long period of wide disparity after the crisis. As illustrated in figure A2, both series have fluctuated around a growth rate in the region of 2 per cent per annum. Adjusting for inflation we can see that real wages have continued to fall. It is falling real wages that have allowed firms to hoard labour without a significant pick-up in unit labour costs, except in 2009. Our preferred measure of wages is compensation per employee hour. We expect this measure of average earnings to accelerate from 2 per cent this year to around 2 3/4 per cent per annum in 2012, rising to 3 1/2 per cent per annum on average over 2013-15. Moderate wage growth will compensate for a continued period of weak productivity growth, restraining the expected rise in unit labour costs. (11) A sharper pick-up in nominal wage growth could well lead to a significant weakening in labour demand and consequently a sharper rise in unemployment than we currently expect.

Demand

The economy has been largely flat over the past three quarters, with weak growth in the first quarter of this year balancing out the fall in the final quarter of 2010 and negligible growth since. Domestic demand declined by 0.2 per cent points in the fourth quarter of 2010 and by a further 0.9 per cent in the first quarter of 2011 (see figure 7). Export growth contributed to GDP growth in the first quarter of this year, but the significant contribution from net trade to economic growth was due to weak import growth rather than particularly strong export growth.

The decline in domestic demand in the final quarter of 2010 came from two primary sources, namely sharp falls in gross fixed investment and consumer spending, although the other components were also weak. However, with the exception of government spending which saw a small rise, the decline in domestic demand in the first quarter of this year was due to decreases in all its components. In particular, it appears that firms have been depleting inventories to meet demand rather than maintaining production, which could be seen as a response to the weak domestic demand from the previous period (see figure 7). However, the contribution of the quarterly alignment adjustment was significant. Including the adjustment, the change in inventories subtracted 0.7 percentage points from GDP growth. Excluding the adjustment, it subtracted only 0.4 percentage point from GDP growth (see figure A3).

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We assume that the government is successful in implementing the reduction in real government consumption over the course of the current parliamentary term (ending in 2015) projected by the OBR. The implied path for government consumption is for an expansion of 0.8 per cent for this year, although the expansion is due to developments in the first half of this year. We assume that government consumption declines by 1.2 per cent in 2012. The overall cumulative effect is to subtract 1.6 percentage points from GDP growth over the next five years.

We expect gross fixed investment to fall by 0.5 per cent in 2011, as private sector investment fails to offset a sharp fall in general government investment. Even though the speed of contraction in general government investment is expected to accelerate into 2012, the private sector is forecast to more than compensate for this. Overall gross fixed investment is expected to rise by almost 3 per cent in 2012. Private consumption, likewise, is set to record a decline of 0.8 per cent for 2011 but will nevertheless recover in coming months. We expect relatively weak growth rates in consumer spending, at 0.7 and 1.6 per cent in 2012 and 2013 respectively. It is only at the end of 2014 that we expect the level of consumer spending to return to the pre-recession peak in the first quarter of 2008.

Overall we expect domestic demand growth to be sluggish. Following a fall of 0.3 per cent this year, we expect growth of 0.6 per cent in 2012, which just offsets the decline in 2011. Pre-recession levels of domestic demand are forecast to be recovered in 2014, but it is only in 2015 that the rate of growth in the domestic economy is expected to reach 2 per cent per annum.

Net trade has been significantly more robust than domestic demand in the first quarter of this year, contributing 1.4 percentage points to output growth in 2011Q1. This came from both a decline in demand for imports of goods and services and an increase in external demand for exports of a similar magnitude, improving the trade balance by 6.7 billion [pounds sterling] overall. Throughout the second quarter of this year, the trade deficit has worsened slightly but not enough to materially offset the improvement seen in the first quarter.

The gradual recovery in exports since mid-2009 has been driven by demand from outside the European Union which surpassed its pre-recession level a year ago, as illustrated in figure A4. Recent months have seen much weaker demand from outside the EU, with the deficit on trade in goods widening by 1.7 billion [pounds sterling] in the three months from March to May. This widening is largely attributable to the rising value of oil imports relative to exports, with net imports in oil increasing in value by 541 million [pounds sterling] between the three months to May and the three months to February. A net decline of 610 million [pounds sterling] in intermediate goods exports is also a primary cause, as well as a 250 million [pounds sterling] decline in the net export of consumer goods other than cars. It appears that the spike in exports to non-EU countries through the first few months of 2011 was due to uncharacteristically high values of exports in intermediate goods, capital goods and consumer goods other than cars over that period, and recent months have witnessed a correction of this. Demand from within the European Union has experienced a much weaker recovery, but in May it finally reached the level of exports seen prior to the recession, in March 2008.

Future global growth patterns suggest that non-EU and in particular emerging markets, such as China and India, will become an increasingly important source of demand for UK goods and services. However, this structural shift in the UK's trade patterns is a longer-term trend. The EU will continue to dominate the demand for UK goods and services. Any weakening of demand for UK exports in the EU due to the sovereign debt crisis poses a significant downside risk to the UK achieving a robust recovery. But such scenarios remain a risk rather than a central forecast. We expect the demand for UK exports to all countries to grow by around 6 1/2 per cent this year and next, falling back to 5 1/2-6 per cent per annum in the medium term.

Household sector

Recent inflationary pressures in the economy and constrained credit conditions have reduced the spending power of UK households in recent months. In particular, real disposable incomes have been weak. As noted in the April Review, real incomes recorded their first annual fall since 1981 in 2010, when they fell by 0.8 per cent. The largest component of incomes is employee compensation, a product of total employees, average hours worked per quarter and average hourly compensation. The decline in the level of employment combined with falling real wages were the major contributors to the fall in real incomes experienced by UK households.

We expect real disposable incomes to fall by a further 1.1 per cent this year. Much of the decline has already occurred. Data for the first quarter of this year suggest that real disposable incomes have continued to decline, falling by 0.8 per cent per quarter. The erosion of real incomes is not expected to persist. The fundamental driver of this is the fallback in the rate of inflation close to target in 2012 and beyond. In 2012 we expect real disposable incomes to grow by 1.8 per cent per annum, increasing to around 2 1/2 per cent per annum in the medium term.

Retail sales have been reasonably strong throughout most of the first half of 2011 relative to their performance throughout 2010. However, growth over the three-month period to June compared with a year earlier was only 0.9 per cent, and remains some way off the robust rates of growth seen in the second half of 2009. Retail sales constitute around a third of overall consumer spending, which has declined in real terms at the start of this year. We expect consumer spending to decline in 2011, overall, due to the effect of falling real incomes and further declines in real house prices. We expect a temporary reduction in the household saving ratio to limit the fall on consumer spending this year. As a result consumer spending does not fall completely in line with decline in real disposable incomes.

The household saving rate fell slightly in the first quarter of 2011 to 4.6 per cent. This remains significantly higher than the pre-recession rates of around 2-3 per cent seen in 2007. Figure 8 illustrates the downwards trajectory followed throughout the seven years leading up to the financial crisis which broke in 2007, where households increasingly consumed more of their incomes rather than saving. There was a dip in the first quarter of 2008 where households were dissaving, but since then the household saving rate has risen steeply, possibly reflecting precautionary saving due to an increased uncertainty about future incomes, alongside the use of incomes to reduce financial liabilities rather than boost consumption (see figure 2). As noted above, the past year has seen the saving rate start to moderate once more, and in the past six months or so this may be due to households trying to maintain their consumption habits in the face of falling real disposable incomes. We do not expect this decline to continue however, and, as personal incomes start to rise in the medium term, we forecast the saving ratio to rise again to rates of around 6-8 per cent from 2012 onwards (figure A6).

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The UK housing market remains stagnant. Both the Nationwide and Halifax house price indices suggest house prices are continuing to fall year-on-year. Our preferred measure of house prices, a seasonally adjusted version of the Department for Communities and Local Government mix-adjusted house price index, lags these two house price series. This index reports year-on-year growth in the first quarter of this year, albeit at a significantly slowing rate. We expect house prices in nominal terms to fall, year-on-year, throughout the remainder of this year and into 2012 and 2013. However, with regard to the direct effect on consumption as a wealth effect, it is real house price changes that matter. By 2015 we expect real house prices to be around 11 per cent below their level in 2010. This is around 20 per cent below the peak of 2007. The falling value of real housing alongside the prospects of rising interest rates and increased uncertainty about the future are expected to raise households' average propensity to save. This shift from a reliance on real capital gains in the housing market to fund future consumption patterns and rely instead on the accumulation of productive financial assets is a significant part of the re-balancing of the UK economy.

Supply conditions

In the three-month period from March to May 2011 there was no change in the employment rate from the previous three-month period from December 2010 to February 2011. Between these respective periods there was a 0.1 percentage point decline in the unemployment rate, and an increase in the inactivity rate of equal magnitude, indicating that the unemployed are not being soaked up into employment but rather are choosing to exit the labour force. However, much of this rise is due to 16-24 year olds in full-time education rather than active disengagement from the labour market for other reasons. It is likely that the choice of education is due to weak employment prospects for the young.

In aggregate the UK labour market continues to perform remarkably well, given the sharp fall in GDP and subsequent poor GDP growth to date. In light of this we have revised our forecast for the level of employment upwards and expect it to rise by 0.7 per cent this year. As a consequence we expect the rise in unemployment to be significantly more modest in the second half of this year than previously projected. We expect the unemployment rat e to rise to a peak of 8.3 per cent in the middle of next year, but this is due to a stalled labour market rather than a fall in employment.

Average hours worked declined by 0.3 per cent and 1.3 per cent in 2008 and 2009, respectively. The reduction in working hours was an approach by UK employers to reduce unit labour costs without resorting to reducing employee levels. (12) In 2010 average hours increased by 0.2 per cent. We estimate that average hours worked fell by 1.3 per cent in the second quarter of 2011. This is most likely due to the additional bank holiday for the Royal Wedding. (13) Even with a return to more normal levels in the second half of 2011, the number of hours worked per employee is expected to fall by 0.3 per cent this year. We expect some recovery in average hours worked in 2012 and 2013.

Figures 9 and 10 illustrate growth in labour productivity as measured by output per person hour, as well as growth in employment for the UK and the US, respectively. The UK economy has experienced particularly weak growth since 2008, and this is not expected to pick up in the next five years. Since mid-2008 employment in the UK has been far more resilient relative to its performance in previous recessions. This indicates that labour hoarding has been taking place, which has been facilitated by the flexibility of real wages, allowing firms to reduce input costs per worker and thereby retain employees in the face of falling profitability. As a result, labour productivity in the UK has fallen dramatically over this period. By contrast, the US experienced a much larger fall in employment over the recessionary period. As a result, labour productivity has actually increased over the course of the recession. (14) In contrast to the UK, real wages in the US continued to grow in 2009-10. It would seem that the UK and the US had two divergent approaches to the recession with regards to the labour market.

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There remains the important question of whether this pronounced period of labour hoarding is set to continue in the UK. We focus on two possible scenarios. (15) The first is the forecast reported in table A7. We expect labour hoarding to persist and that productivity growth will grow by only 1 per cent per annum, on average, over the next half decade. The second scenario is that our employment forecasts are too optimistic, and firms attempt to regain higher productivity growth by shedding labour. If there were no growth in employment between 2012 and 2013 for example, we would expect to see a sharp rise in the unemployment rate to 8.7 per cent over the same period, whereas our current forecast is for a decline to an unemployment rate of 7.8 per cent in 2013. The second scenario should not be dismissed. The revision to our forecast since April has implications for the profitability of the UK corporate sector even if unit labour costs growth continues to be subdued. As figure 11 shows, we have revised down corporate profitability as a per cent of GDP. This reduction is in large part due to labour hoarding at a higher rate than we were previously projecting.

Public finances

The government's fiscal consolidation plan began in earnest this year. The publication of data for the first quarter of this year suggests that the initial performance of the consolidation plan has been relatively poor. The current budget deficit of central government, at 37.6 billion [pounds sterling], for April to June 2011, was identical to the figure for the same period a year ago. However, factors such as the bank Payroll Tax, which boosted receipts by 3.5 billion [pounds sterling] in April 2010, distort the comparison somewhat.

Our forecast for the public finances is reported in table A8. It is broadly unchanged from that published in the April Review. Public sector net borrowing declined from 11 per cent of GDP in 2009-10 to 9.6 per cent of GDP in 2010-11. This was, to a large extent, due to the ending of the temporary fiscal stimulus to the UK economy. We expect public sector net borrowing to be reduced by only 1 per cent of GDP this fiscal year, around half the improvement expected by the OBR. This is due to less optimism about economic growth, but also a view that tax revenues will prove to be less buoyant than the OBR expects. It is not just economic growth, but also this composition of growth that is an important determinant of tax revenues. Consumer spending is tax-rich relative to other sources of economic growth and it is the weakness in consumer spending growth in the short term that explains, to a large extent, the difference between the NIESR and OBR forecasts.

We expect public sector net borrowing to fall gradually over the term of the current Parliament, reaching 3.6 per cent of GDP in 2015-16. The government's forward looking primary target in its Fiscal Mandate is for the cyclically adjusted current budget (public sector net borrowing less net investment) to be in balance in five years time (currently 2015-16). The OBR expect this target to be achieved with a probability of 70 per cent. We do not expect this target to be met. Our forecast shows a current budget deficit of around 2 per cent of GDP. In cyclically-adjusted terms this is around 1 per cent of GDP. This is not to suggest that further consolidation should be implemented now. The benefit of a forward looking fiscal plan is that the Chancellor has significant time in which to adjust his fiscal plans to meet the primary target.

The standard risks to the public finances come via the automatic stabilisers due to a stronger/weaker economy. It would be counterproductive for fiscal policy to try to offset their operation. Aside from the standard risks to the public finance forecasts there are additional 'policy risks'. The Chancellor has committed himself to keeping the fiscal consolidation plan on track. (16) However, as the IMF notes in the recent Article IV Consultation Concluding Statement, (17) should economic growth be materially weaker than expected the option of loosening fiscal policy should not be discounted. There are also policy decisions that will almost certainly be introduced that we have not yet taken into account. These include the auction of 4G spectrum licences in 2012 and sale of public sector banking assets. (18) It is more than likely that the revenues from these asset sales will be used to reduce the level of government debt. It should be noted that sales of assets such as the public sector banks have negative implications for future government revenue streams. However, this does not affect the forecast presented in table A8 as we exclude the effect of financial sector interventions.

Accumulation

The UK economy continues to require financing from abroad to fund its investment. Such funding is observed in the form of a deficit on the current account. The UK has been a persistent net borrower from the rest of the world since 1983 (see figure 12). (19) Running a persistent current account deficit implies the sale of domestic assets abroad. Since 1995 the net overseas asset position (foreign assets less foreign liabilities) of the UK has been negative (see figure 12). In 2006 this negative net overseas asset position reached 25 per cent of GDP. However, this marks a recent trough in the UK's net overseas asset position, which improved by around 10 per cent of GDP by 2010. This has less to do with the UK's borrowing needs and more to do with the revaluations of assets and liabilities due to the depreciation of sterling since the end of 2007.

The position of a country as net borrower or lender does not provide a view on whether a level of investment is optimal or not. Rather it simply highlights whether the level of domestic saving is sufficient to fund this investment. Such views must be based on assumptions about the shape of the economy. In the case of the UK, if we assume that the depreciation rate is 5 per cent, and that the potential rate of growth is 2.1 per cent in the medium term, then gross fixed investment of almost 15 per cent of GDP would be enough to maintain a capital-output ratio of 2.1. We estimate that the capital-output ratio is currently around 2.3 and that this ratio will gradually adjust downwards. Our forecast (see table A9) has investment as a share of GDP falling from 15 per cent in 2010 to around 14 and 14.4 per cent over the period 2011-14, before recovering to almost 15 per cent of GDP in 2015. This is in large part due to the reduction in the volume of general government investment--a central plank of the fiscal consolidation plan. We expect general government investment to fall from 2.5 per cent of GDP in 2010 to 1.3 per cent of GDP in 2015. Business investment is expected to remain relatively stable at around 8 3/4 per cent of GDP over the next five years, while investment by the household sector is expected to rise gradually to around 4 3/4 per cent of GDP, from 3.5 per cent of GDP, on average, in 2010. This does not return housing investment to its recent peak of 5.8 per cent of GDP in 2007. This is mirrored in the volume of housing investment (table A6), which is not expected to recover the peak of 2007, even by 2015. (20)

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Given the persistent deficit on the current account, saving in the UK economy has clearly been too low to fund UK investment. We do not expect the corporate sector saving rate to increase any further, rather we forecast a gradual reduction in the saving rate from 14.7 per cent of GDP in 2010 to around 11 1/2 per cent in 2015. However, we expect the corporate sector to retain its position as a net lender to the rest of the economy. The forecast rise in national saving, from 11.8 per cent of GDP in 2010 to 15 1/2 per cent in 2015 is due to the simultaneous increase in household sector saving and the reduction in dissaving by the general government sector. In 2009 and 2010 the level of national saving was only just enough to fund the level of capital consumption in the UK economy, at around 10 per cent of GDP. Looking ahead we expect the rise in national saving not only to fund investment in the UK, but also to accumulate foreign assets by lending abroad. Ageing populations such as the UK's need an excess of saving in order to fund future consumption. The government appears to recognise the problems associated with the financial liabilities related to an ageing population. The extent of this realisation will be seen in the response of the government to the automatic uprating of the state pension age (the review of which was announced in Budget 2011), the analysis by the OBR in their Fiscal Sustainability Report and the work of the Dilnott Commission on Funding of Care and Support.

The medium term

The trend rate of growth is an estimate of the rate of growth of the productive potential of the economy. Trend growth is determined by capital, labour and energy inputs and the growth of total factor productivity. We expect the productive potential of the UK economy to grow by around 2.1 per cent per annum over the next decade. This is significantly lower than the average rate of 2.6 per cent per annum for the decade preceding 2008.

Shocks to the factor inputs can shift the trend rate of growth. For example, the rate of labour force growth is expected to moderate over the medium term as the rate of growth in the population of working age slows. Policy can be implemented to adjust this. The government has announced its intention to bring forward the increase in the state pension age to 66 from the 2024-6 period to 2020, but this will have only a limited effect on the economic growth reported in table A10.

A more immediate policy effect, both on the size of the labour force and on productivity, is the effect of the government's migration policy. A reduction in net migration reduces labour force growth. Moreover, as highlighted by the Migration Advisory Committee, the principle policy measures implemented by the government to reduce net migration impact on skilled workers and students, so the impact will be to reduce the average skill levels of the workforce and hence productivity. Such policies will therefore have a negative impact on trend growth, which could be significant. (21)

Our view of the medium term is determined by the adjustment of the economy to the current disequilibria. Our estimates suggest there is currently a negative output gap of around 4 per cent. The speed of GDP growth in the medium term is around 2 1/2 per cent per annum. Such above trend growth is necessary if the output gap is to be closed. For the output gap to be closed more quickly, a faster rate of growth would be required. However, in each and every year from 2011 to 2015, GDP growth is constrained by planned fiscal consolidation.

The Plan for Growth suggests a set of supply side reforms to stimulate economic growth. There is little or no evidence to suggest reductions in employment regulation will increase growth. (22) However, successful implementation of measures to reform the planning system and improve educational outcomes for young people, for example, could well increase the trend and actual rates of growth in the economy over the medium to longer term, although any such impact will be countered by the negative effect of the immigration restrictions described above. A comprehensive and properly evidenced programme of supply-side reform is essential for boosting trend growth. But in the short term the UK economy is suffering from deficient demand rather than deficient supply.

Public sector net borrowing is expected to average 2.4 per cent over the period 2016-20. This is due to continued robust economic growth, but also to the assumption that income tax rates are adjusted to bring the current budget back to balance over this period.

Any acceleration in growth above our current projections will result in a more rapid improvement in the position of the public finances. This is especially the case if additional economic growth is due to more tax-rich consumption rather than relatively tax-poor export growth.

Appendix--Forecast details

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Table A1. Exchange rates and interest rates

 UK exchange rates FTSE
 All-share
 Effective Dollar Euro index
 2005 = 100

2005 100.00 1.82 1.46 2587.6
2006 100.75 1.84 1.47 3022.6
2007 102.89 2.00 1.46 3306.3
2008 90.69 1.85 1.26 2728.0
2009 81.16 1.57 1.12 2326.0
2010 81.04 1.55 1.17 2818.3
2011 80.30 1.61 1.14 3077.7
2012 79.87 1.61 1.13 3003.0
2013 80.91 1.61 1.15 3002.0
2014 82.09 1.61 1.17 3013.6
2015 83.19 1.61 1.19 3043.3
2010 Q1 80.05 1.56 1.13 2778.8
2010 Q2 80.43 1.49 1.17 2765.9
2010 Q3 82.53 1.55 1.20 2744.2
2010 Q4 81.14 1.58 1.16 2984.1

2011 Q1 81.80 1.60 1.17 3085.1
2011 Q2 80.39 1.63 1.13 3078.9
2011 Q3 79.51 1.61 1.13 3081.7
2011 Q4 79.51 1.61 1.13 3065.2

2012 Q1 79.51 1.61 1.13 3043.3
2012 Q2 79.76 1.61 1.13 3002.6
2012 Q3 80.00 1.61 1.14 2980.9
2012 Q4 80.23 1.61 1.14 2985.4

Percentage changes

2005/2004 -1.6 -0.7 -0.9 15.0
2006/2005 0.7 1.3 0.4 16.8
2007/2006 2.1 8.6 -0.4 9.4
2008/2007 -11.9 -7.4 -14.0 -17.5
2009/2008 -10.5 -15.5 -10.6 -14.7
2010/2009 -0.2 -1.2 3.8 21.2
201112010 -0.9 4.3 -2.2 9.2
2012/2011 -0.5 -0.4 -0.6 -2.4
2013/2012 1.3 0.0 1.4 0.0
2014/2013 1.5 0.2 1.6 0.4
2015/2014 1.3 0.1 1.5 1.0

2010Q4/09Q4 0.4 -3.3 5.2 11.3
2011Q41/10Q4 -2.0 1.6 -3.1 2.7
2012Q4/11Q4 0.9 -0.1 1.0 -2.6

 Interest rates

 Bank
 3-month Mortgage 10-year World Rate
 rates interest gilts (a) (b)

2005 4.7 6.5 4.4 3.1 4.50
2006 4.8 6.5 4.5 4.0 5.00
2007 6.0 7.4 5.0 4.6 5.50
2008 5.5 6.9 4.5 3.4 2.00
2009 1.2 4.0 3.7 1.1 0.50
2010 0.7 4.0 3.6 1.0 0.50
2011 0.8 4.0 3.4 1.2 0.50
2012 0.7 4.0 3.3 1.6 0.75
2013 1.0 4.2 3.6 2.0 1.00
2014 1.6 4.7 3.9 2.5 2.00
2015 2.3 5.1 4.2 3.1 2.50
2010 Q1 0.6 4.1 4.1 0.9 0.50
2010 Q2 0.7 4.0 3.7 1.0 0.50
2010 Q3 0.8 3.9 3.2 1.0 0.50
2010 Q4 0.8 3.9 3.3 1.0 0.50

2011 Q1 0.8 4.0 3.7 1.0 0.50
2011 Q2 0.8 4.0 3.4 1.1 0.50
2011 Q3 0.8 4.0 3.1 1.2 0.50
2011 Q4 0.8 4.0 3.2 1.3 0.50

2012 Q1 0.6 3.9 3.2 1.4 0.50
2012 Q2 0.7 3.9 3.3 1.5 0.75
2012 Q3 0.9 4.1 3.3 1.6 0.75
2012 Q4 0.9 4.1 3.4 1.7 0.75

Percentage changes

2005/2004
2006/2005
2007/2006
2008/2007
2009/2008
2010/2009
201112010
2012/2011
2013/2012
2014/2013
2015/2014

2010Q4/09Q4
2011Q41/10Q4
2012Q4/11Q4

Notes: We assume that bilateral exchange rates for the fourth
quarter of this year are the average of the first three weeks of
July. We then assume that bilateral rates remain constant for
the final quarter of 2011 and first quarter of 2012 before moving
in-line with the path implied by the backward-looking uncovered
interest rate parity condition based on interest rate
differentials relative to the US. (a) Weighted average of central
bank intervention rates in OECD economies. (b) End of period.

Table A2. Price indices 2006=100

 World
 Unit Whole- oil
 labour Imports Exports sale price price
 costs deflator deflator index(a) ($)(b)

2005 97.7 97.1 97.2 98.5 51.8
2006 100.0 100.0 100.0 100.0 63.4
2007 102.7 100.2 101.6 101.4 70.5
2008 105.1 112.1 113.7 105.1 95.7
2009 111.2 116.2 116.8 107.7 61.8
2010 113.0 121.3 121.7 111.0 78.8
2011 114.7 129.4 126.2 115.2 111.4
2012 116.0 132.5 127.6 118.8 118.5
2013 118.3 134.4 129.7 121.0 125.8
2014 120.8 136.3 132.0 123.1 131.1
2015 123.1 138.3 134.3 125.4 134.2

Percentage changes

2005/2004 2.6 3.7 1.0 1.0 44.4
2006/2005 2.4 2.9 2.8 1.5 22.4
2007/2006 2.7 0.2 1.6 1.4 11.2
2008/2007 2.3 12.0 12.0 3.7 35.7
2009/2008 5.8 3.6 2.7 2.5 -35.4
2010/2009 1.6 4.4 4.1 3.0 27.6
2011/2010 1.5 6.7 3.7 3.8 41.3
2012/2011 1.1 2.4 1.1 3.1 6.4
2013/2012 2.0 1.5 1.6 1.8 6.1
2014/2013 2.1 1.4 1.8 1.7 4.2
2015/2014 1.9 1.5 1.7 1.9 2.4

2010Q4/09Q4 0.8 5.9 3.5 3.0 13.8
2011Q4/10Q4 1.5 5.4 3.6 4.4 35.1
2012Q4/11Q4 1.5 2.2 1.2 2.3 4.0

 Retail price index
 GDP
 Consump- deflator Excluding Consumer
 tion (market All mortgage prices
 deflator prices) items interest index

2005 97.4 97.0 96.9 97.1 97.7
2006 100.0 100.0 100.0 100.0 100.0
2007 102.9 103.0 104.3 103.2 102.3
2008 106.1 106.1 108.4 107.6 106.0
2009 107.5 107.6 107.9 109.8 108.3
2010 112.0 110.7 112.8 115.0 111.9
2011 117.9 114.3 118.6 120.8 116.6
2012 120.1 116.0 121.5 123.6 118.8
2013 122.2 118.1 124.2 126.3 120.9
2014 124.6 120.6 1275 129.4 123.2
2015 127.0 123.0 131.5 132.7 125.6

Percentage changes

2005/2004 2.4 2.0 2.8 2.3 2.1
2006/2005 2.7 3.0 3.2 2.9 2.3
2007/2006 2.9 3.0 4.3 3.2 2.3
2008/2007 3.1 3.0 4.0 4.3 3.6
2009/2008 1.3 1.4 -0.5 2.0 2.2
2010/2009 4.2 2.9 4.6 4.8 3.3
2011/2010 5.2 3.2 5.1 5.0 4.2
2012/2011 1.9 1.5 2.5 2.3 1.9
2013/2012 1.7 1.8 2.2 2.2 1.8
2014/2013 1.9 2.1 2.7 2.5 1.9
2015/2014 2.0 2.0 3.1 2.5 2.0

2010Q4/09Q4 4.8 3.1 4.7 4.7 3.4
2011Q4/10Q4 4.3 2.6 4.7 4.5 3.9
2012Q4/11Q4 1.7 1.4 2.1 2.1 1.7

Notes:

(a) Excluding food, beverages, tobacco and petroleum products.

(b) Per barrel, average of Dubai and Brent spot prices.

Table A3. Gross domestic product and components of expenditure

billion [pounds sterling], 2006 prices

 Final consumption Gross capital
 expenditure formation

 Households General Gross Changes in
 & NPISH (a) gov't fixed inventories
 investment (b)

2005 836.6 281.3 213.6 4.6
2006 852.0 285.2 227.2 5.5
2007 870.8 288.8 245.1 7.4
2008 874.5 293.5 232.8 1.4
2009 846.9 296.3 197.0 -14.8
2010 853.1 299.4 204.4 4.2
2011 846.2 301.7 203.4 5.5
2012 851.0 298.2 209.3 4.8
2013 865.3 292.8 219.0 4.8
2014 883.1 285.8 231.6 4.8
2015 903.9 280.4 244.4 4.8

Percentage changes

2005/2004 2.2 2.0 2.4 -13.7
2006/2005 1.8 1.4 6.4 19.3
2007/2006 2.2 1.3 7.8 34.3
2008/2007 0.4 1.6 -5.0 -80.8
2009/2008 -3.2 1.0 -15.4 -1141.5
2010/2009 0.7 1.0 3.7 -128.6
201112010 -0.8 0.8 -0.5 29.6
2012/2011 0.7 -1.1 2.9 -12.3
2013/2012 1.6 -1.8 4.6 0.0
2014/2013 2.1 -2.4 5.7 0.0
2015/2014 2.3 -1.9 5.5 0.0

Decomposition of growth
in GDP (d)

2005 1.4 0.4 0.4 -0.1
2006 1.2 0.3 1.1 0.1
2007 1.4 0.3 1.3 0.1
2008 0.3 0.3 -0.9 -0.4
2009 -2.0 0.2 -2.6 -1.2
2010 0.5 0.2 0.6 1.5
2011 -0.5 0.1 -0.1 0.1
2012 0.4 -0.3 0.4 -0.1
2013 1.0 -0.4 0.7 0.0
2014 1.3 -0.5 0.9 0.0
2015 1.5 -0.4 0.9 0.0

 Domestic Total Total Total
 demand exports final exports Net
 (c) expenditure (c) trade

2005 1336.6 340.3 1676.8 384.5 -44.2
2006 1369.9 378.0 1747.9 419.6 -41.5
2007 1412.0 368.3 1780.3 416.3 -48.0
2008 1402.2 372.1 1774.3 411.1 -39.0
2009 1325.5 334.6 1660.1 362.0 -27.4
2010 1361.0 352.0 1713.0 393.7 -41.8
2011 1356.7 376.5 1733.3 398.0 -21.5
2012 1364.3 401.5 1765.7 404.0 -2.5
2013 1381.9 425.6 1807.5 415.2 10.4
2014 1405.3 449.6 1854.9 429.7 19.9
2015 1433.5 471.5 1905.0 446.1 25.5

Percentage changes

2005/2004 2.1 7.9 3.2 7.1
2006/2005 2.5 11.1 4.2 9.1
2007/2006 3.1 -2.6 1.9 -0.8
2008/2007 -0.7 1.0 -0.3 -1.2
2009/2008 -5.5 -10.1 -6.4 -11.9
2010/2009 2.7 5.2 3.2 8.8
201112010 -0.3 7.0 1.2 1.1
2012/2011 0.6 6.6 1.9 1.5
2013/2012 1.3 6.0 2.4 2.8
2014/2013 1.7 5.6 2.6 3.5
2015/2014 2.0 4.9 2.7 3.8

Decomposition of growth
in GDP (d)

2005 2.2 2.0 4.2 -2.0 0.0
2006 2.6 2.9 5.5 -2.7 0.2
2007 3.2 -0.7 2.4 0.2 -0.5
2008 -0.7 0.3 -0.4 0.4 0.7
2009 -5.6 -2.8 -8.4 3.6 0.9
2010 2.7 1.3 4.1 -2.4 -1.1
2011 -0.3 1.9 1.5 -0.3 1.5
2012 0.6 1.9 Z4 -0.4 1.4
2013 1.3 1.8 3.1 -0.8 0.9
2014 1.7 1.7 3.4 -1.0 0.7
2015 20 1.5 3.5 -1.2 0.4

 GDP
 at
 market
 prices

2005 1292.3
2006 1328.4
2007 1364.0
2008 1363.1
2009 1296.7
2010 1314.2
2011 1331.0
2012 1357.7
2013 1388.3
2014 1421.2
2015 1454.9

Percentage changes

2005/2004 2.2
2006/2005 2.8
2007/2006 2.7
2008/2007 -0.1
2009/2008 -4.9
2010/2009 1.4
201112010 1.3
2012/2011 2.0
2013/2012 2.3
2014/2013 2.4
2015/2014 2.4

Decomposition of growth
in GDP (d)

2005 2.2
2006 2.8
2007 2.7
2008 -0.1
2009 -4.9
2010 1.4
2011 1.3
2012 2.0
2013 2.3
2014 2.4
2015 2.4

Notes: (a) Non-profit institutions serving households. (b)
Including acquisitions less disposals of valuables and quarterly
alignment adjustment (c) Includes Missing Trader Intra-
Community Fraud. (d) Components may not add up to total GDP
growth due to rounding and the statistical discrepancy included
in GDP.

Table A4. External sector

 Net
 Exports Imports trade in
 of goods of goods goods
 (a) (a) (a)

 billion [pounds sterling], 2006
 prices (b)

2005 218.6 289.7 -71.1
2006 243.6 319.9 -76.3
2007 218.5 311.3 -92.8
2008 221.5 305.7 -84.1
2009 194.2 267.3 -73.0
2010 215.0 297.9 -82.9
2011 235.8 303.9 -68.1
2012 252.8 308.0 -55.1
2013 268.8 316.2 -47.4
2014 284.0 327.2 -43.2
2015 297.6 339.6 -42.1

Percentage changes

2005/2004 8.9 7.0
2006/2005 11.5 10.4
2007/2006 -10.3 -2.7
2008/2007 1.4 -1.8
2009/2008 -12.3 -12.6
2010/2009 10.7 11.5
2011/20/0 9.7 2.0
2012/2011 7.2 1.3
2013/2012 6.3 2.7
2014/2013 5.7 3.5
2015/2014 4.8 3.8

 Exports Imports Net
 of of trade in
 services services services

 billion [pounds sterling], 2006
 prices (b)

2005 121.7 94.8 27.0
2006 134.4 99.6 34.8
2007 149.8 105.0 44.8
2008 150.6 105.5 45.1
2009 140.4 94.8 45.6
2010 137.0 95.8 41.1
2011 140.7 94.1 46.6
2012 148.6 96.0 52.6
2013 156.8 99.0 57.8
2014 165.6 102.6 63.0
2015 174.0 106.4 67.5

Percentage changes

2005/2004 6.3 7.3
2006/2005 10.4 5.1
2007/2006 11.5 5.4
2008/2007 0.5 0.5
2009/2008 -6.8 -10.2
2010/2009 -2.4 1.1
2011/20/0 2.7 -1.8
2012/2011 5.6 2.0
2013/2012 5.5 3.1
2014/2013 5.6 3.6
2015/2014 5.1 3.8

 Export
 price World Terms Current
 competitiveness trade of trade balance
 (c] (d) (e)

 2006=100 % of GDP

2005 98.0 92.5 100.1 -2.6
2006 100.0 100.0 100.0 -3.4
2007 104.0 107.3 101.4 -2.6
2008 101.4 109.9 101.4 -1.6
2009 95.1 97.7 100.5 -1.7
2010 97.2 107.0 100.3 -3.2
2011 99.6 113.9 97.6 -1.8
2012 96.2 121.3 96.3 -0.7
2013 96.3 128.7 96.4 0.1
2014 96.8 135.7 96.9 0.6
2015 97.0 142.0 97.1 0.7

Percentage changes

2005/2004 -2.1 7.6 -2.6
2006/2005 2.0 8.1 -0.1
2007/2006 4.0 7.3 1.4
2008/2007 -2.6 2.5 0.0
2009/2008 -6.1 -11.1 -0.9
2010/2009 2.1 9.5 -0.2
2011/20/0 2.5 6.5 -2.8
2012/2011 -3.4 6.4 -1.3
2013/2012 0.1 6.1 0.2
2014/2013 0.5 5.5 0.4
2015/2014 0.3 4.6 0.2

Notes: (a) Includes Missing Trader Intra-Community Fraud.
(b) Balance of payments basis. (c) A rise denotes a loss in UK
competitiveness. (d) Weighted by import shares in UK export
markets. (e) Ratio of average value of exports to imports.

Table A5. Household income and expenditure

 Total Gross
 Average (a) Compensation personal disposable
 earnings of employees income income

 2006=100 billion [pounds sterling],
 current prices

2005 95.7 677.5 1081.1 817.6
2006 100.0 713.0 1133.0 853.1
2007 105.0 752.2 1179.8 881.5
2008 106.6 769.2 1230.3 919.5
2009 109.3 774.0 1241.4 942.2
2010 112.9 797.2 1278.2 974.1
2011 115.1 819.7 1331.7 1013.9
2012 118.8 845.3 1383.8 1051.8
2013 122.6 881.8 1445.1 1095.3
2014 126.2 921.8 1514.1 1143.8
2015 130.1 961.7 1587.8 1197.1

Percentage changes

2005/2004 3.6 4.8 5.3 4.5
2006/2005 4.5 5.2 4.8 4.3
2007/2006 5.0 5.5 4.1 3.3
2008/2007 1.5 2.3 4.3 4.3
2009/2008 2.6 0.6 0.9 2.5
2010/2009 3.3 3.0 3.0 3.4
2011/2010 2.0 2.8 4.2 4.1
2012/2011 3.2 3.1 3.9 3.7
2013/2012 3.1 4.3 4.4 4.1
2014/2013 2.9 4.5 4.8 4.4
2015/2014 3.1 4.3 4.9 4.7

 Final consumption
 Real expenditure Saving House
 disposable ratio prices
 income(b) Total Durable (c) (d)

 billion [pounds sterling], per cent 2006=100
 2006 prices

2005 839.3 836.6 85.8 3.9 94.1
2006 853.1 852.0 91.7 3.5 100.0
2007 856.6 870.8 97.9 2.6 110.9
2008 866.3 874.5 100.8 2.0 109.9
2009 876.4 846.9 99.9 6.0 101.3
2010 869.5 853.1 102.9 5.3 108.7
2011 860.0 846.2 102.7 5.1 108.3
2012 875.4 852.0 103.7 6.2 106.8
2013 896.0 865.3 106.5 7.0 106.2
2014 917.9 883.1 109.4 7.4 107.4
2015 942.3 903.9 112.2 7.7 109.5

Percentage changes

2005/2004 2.0 2.2 6.3 5.5
2006/2005 1.6 1.8 6.9 6.3
2007/2006 0.4 2.2 6.7 10.9
2008/2007 1.1 0.4 3.0 -0.9
2009/2008 1.2 -3.2 -0.9 -7.8
2010/2009 -0.8 0.7 2.9 7.3
2011/2010 -1.1 -0.8 -0.1 -0.4
2012/2011 1.8 0.7 1.0 -1.4
2013/2012 2.3 1.6 2.6 -0.5
2014/2013 2.4 2.1 2.8 1.1
2015/2014 2.7 2.3 2.6 2.0

 Net
 worth to
 income
 ratio (e)

2005 6.6
2006 7.0
2007 7.1
2008 6.0
2009 6.5
2010 6.7
2011 6.6
2012 6.4
2013 6.2
2014 6.1
2015 6.1

Percentage changes

2005/2004
2006/2005
2007/2006
2008/2007
2009/2008
2010/2009
2011/2010
2012/2011
2013/2012
2014/2013
2015/2014

Notes: (a) Average earnings equals total labour compensation
divided by the number of employees. (b) Deflated by consumers'
expenditure deflator. (c) Includes adjustment for change in net
equity of households in pension funds. (d) Department for
Communities and Local Government, mix-adjusted. (e) Net worth is
defined as housing wealth plus net financial assets.

Table A6. Fixed investment and capital

billion [pounds sterling], 2006 prices

 Gross fixed investment (a)
 User
 Private General cost of
 Business housing government Total capital (%)
 investment (b)

2005 122.1 67.2 23.7 213.6 17.1
2006 127.9 73.9 25.4 227.2 16.6
2007 144.0 74.1 27.0 245.1 16.5
2008 142.4 56.7 33.6 232.8 16.1
2009 115.5 41.5 40.0 197.0 14.7
2010 119.6 44.2 40.6 204.4 14.2
2011 123.0 42.9 37.4 203.4 15.2
2012 130.7 45.8 32.8 209.3 16.1
2013 138.5 49.6 31.0 219.0 16.0
2014 146.4 54.6 30.5 231.6 16.0
2015 153.4 59.7 31.3 244.4 16.1

Percentage changes

2005/2004 4.5 -4.8 10.9 2.4
2006/2005 4.8 10.0 7.3 6.4
2007/2006 12.5 0.2 6.4 7.8
2008/2007 -1.1 -23.4 24.5 -5.0
2009/2008 -18.9 -26.9 18.9 -15.4
2010/2009 3.5 6.6 1.4 3.7
2011/2010 2.8 -2.9 -7.7 -0.5
2012/2011 6.3 6.6 -12.4 2.9
2013/2012 5.9 8.3 -5.6 4.6
2014/2013 5.8 10.1 -1.4 5.7
2015/2014 4.8 9.3 2.4 5.5

 Corporate
 profit Capital stock
 share of
 GDP (%) Private Public(c)

2005 24.2 2163.9 554.1
2006 25.0 2219.2 564.1
2007 25.2 2301.2 577.1
2008 26.2 2370.7 593.2
2009 25.0 2401.3 612.2
2010 23.8 2415.8 632.7
2011 24.5 2428.9 649.6
2012 25.4 2449.6 661.3
2013 25.6 2478.8 670.8
2014 25.9 2517.7 679.6
2015 26.2 2565.0 688.8

Percentage changes

2005/2004 2.4 1.9
2006/2005 2.6 1.8
2007/2006 3.7 2.3
2008/2007 3.0 2.8
2009/2008 1.3 3.2
2010/2009 0.6 3.4
2011/2010 0.5 2.7
2012/2011 0.9 1.8
2013/2012 1.2 1.4
2014/2013 1.6 1.3
2015/2014 1.9 1.4

Notes: (a) Fixed investment figures exclude the effect of the
transfer of BFNL nuclear reactors to central government in
2005Q2. (b) Includes private sector transfer costs of non-
produced assets. (c) Including public sector non-financial
corporations.

Table A7. Productivity and the labour market

Thousands

 Employment Population
 ILO Labour of
 Total un- force working
 Employees (a) employment (b) age

2005 41134 28770 1467 30237 37419
2006 25095 29025 1674 30699 37707
2007 25212 29228 1654 30882 37916
2008 25408 29440 1783 31223 38090
2009 24924 28961 2394 31355 38236
2010 24852 29035 2479 31514 38481
2011 25059 29242 2495 31737 38799
2012 25038 29241 2645 31886 39023
2013 25322 29558 2494 32052 39257
2014 25714 29984 2235 32219 39495
2015 26013 30317 2067 32384 39728

Percentage changes

2005/2004 1.1 1.0 2.9 1.1 0.9
2006/2005 0.7 0.9 14.1 1.5 0.8
2007/2006 0.5 0.7 -1.2 0.6 0.6
2008/2007 0.8 0.7 7.8 1.1 0.5
2009/2008 -1.9 -1.6 34.3 0.4 0.4
2010/2009 -0.3 0.3 3.6 0.5 0.6
2011/2010 0.8 0.7 0.7 0.7 0.8
2012/2011 -0.1 0.0 6.0 0.5 0.6
2013/2012 1.1 1.1 -5.7 0.5 0.6
2014/2013 1.5 1.4 -10.4 0.5 0.6
2015/2014 1.2 1.1 -7.5 0.5 0.6

Thousands Unemployment, %
 Productivity
 (2006=100) ILO
 Claimant unemployment
 Per hour Manufacturing rate rate

2005 97.7 95.4 2.7 4.9
2006 100.0 100.0 2.9 5.5
2007 101.9 102.6 2.7 5.4
2008 101.4 102.4 2.8 5.7
2009 99.6 98.4 4.7 7.6
2010 100.6 106.2 4.7 7.9
2011 101.6 112.9 4.8 7.9
2012 102.9 119.4 5.3 8.3
2013 103.8 124.7 4.9 7.8
2014 104.7 129.2 4.1 6.9
2015 106.0 133.3 3.7 6.4

Percentage changes

2005/2004 1.2 4.6
2006/2005 2.4 4.9
2007/2006 1.9 2.6
2008/2007 -0.5 -0.3
2009/2008 -1.8 -3.8
2010/2009 1.0 7.9
2011/2010 1.0 6.3
2012/2011 1.3 5.8
2013/2012 0.9 4.4
2014/2013 0.8 3.6
2015/2014 1.2 3.2

Notes: (a) Includes self-employed, government-supported trainees
and unpaid family members. (b) Employment plus ILO unemployment.

Table A8. Public sector financial balance and borrowing
requirement

billion [pounds sterling], fiscal years

 2008-9 2009-10 2010-11

Current Taxes on income 355.2 337.8 352.7
receipts: Taxes on expenditure 167.6 168.8 192.1
 Other current receipts 11.3 8.3 5.4
 Total 534.1 514.8 550.2
 (as a % of GDP) 37.3 36.7 37.4

Current Goods and services 319.0 330.0 338.7
expenditure Net social benefits 171.5 188.4 196.1
 paid
 Debt interest 32.3 31.5 44.4
 Other current 43.0 50.7 53.4
 expenditure
 Total 565.9 600.6 632.5
 (as a % of GDP) 39.5 42.8 43.0

Depreciation 18.9 19.7 20.7
Surplus on public sector -50.7 -105.5 -103.0
 current budget (a)
as a % of GDP) -3.6 -7.5 -7.0

Gross investment 65.7 68.7 59.4
Net investment 46.8 49.0 38.7
(as a % of GDP) 3.3 3.5 2.6

Total managed 631.6 669.3 691.9
 expenditure
(as a % of GDP) 44.1 47.7 47.0

Public sector net 97.5 154.5 141.7
 borrowing
(as a % of GDP) 6.8 11.0 9.6

Financial transactions -71.0 -49.4 2.4
Public sector net cash 168.5 203.9 139.3
 requirement
(as a % of GDP) 11.8 14.5 9.5
Public sector net debt 43.4 53.0 60.3
 (% of GDP)

GDP deflator at market 106.6 108.3 111.6
 prices (2006=100)
Money GDP 1433.4 1403.8 1472.0

Financial balance under Maastricht -4.9 -11.2 -10.3
 (% of GDP) (b)
Gross debt under Maastricht (% of GDP) (b) 52.1 68.1 76.0

 2011-12 2012-13 2013-14

Current Taxes on income 366.5 386.4 407.8
receipts: Taxes on expenditure 203.1 208.1 215.3
 Other current receipts 8.4 9.4 10.6
 Total 577.9 603.9 633.7
 (as a % of GDP) 37.7 38.0 38.2

Current Goods and services 349.2 352.0 354.6
expenditure Net social benefits 202.4 210.8 215.2
 paid
 Debt interest 50.4 51.2 53.6
 Other current 52.0 53.4 55.0
 expenditure
 Total 654.0 667.5 678.3
 (as a % of GDP) 42.6 42.0 40.9

Depreciation 22.0 22.9 23.9
Surplus on public sector -98.1 -86.5 -68.5
 current budget (a)
(s a % of GDP) -6.4 -5.4 -4.1

Gross investment 55.4 52.2 50.8
Net investment 33.4 29.3 27.0
(as a % of GDP) 2.2 1.8 1.6

Total managed 709.4 719.7 729.2
 expenditure
(as a % of GDP) 46.2 45.3 44.0

Public sector net 131.5 115.8 95.5
 borrowing
(as a % of GDP) 8.6 7.3 5.8

Financial transactions -7.0 -8.0 -13.0
Public sector net cash 138.5 123.8 108.5
 requirement
(as a % of GDP) 9.0 7.8 6.5
Public sector net debt 66.7 72.0 75.3
 (% of GDP)

GDP deflator at market 114.8 116.5 118.7
 prices (2006=100)
Money GDP 1534.9 1590.0 1658.2

Financial balance under Maastricht -8.9 -7.6 -6.2
 (% of GDP) (b)
Gross debt under Maastricht (% of GDP) (b) 81.4 86.2 88.8

 2014-15 2015-16

Current Taxes on income 429.9 452.7
receipts: Taxes on expenditure 223.0 232.4
 Other current receipts 12.0 13.5
 Total 664.9 698.7
 (as a % of GDP) 38.4 38.6

Current Goods and services 354.8 359.4
expenditure Net social benefits 223.0 233.5
 paid
 Debt interest 56.4 59.9
 Other current 56.7 58.6
 expenditure
 Total 691.0 711.4
 (as a % of GDP) 39.9 39.3

Depreciation 24.9 25.9
Surplus on public sector -50.9 -38.6
 current budget (a)
(s a % of GDP) -2.9 -2.1

Gross investment 50.6 52.1
Net investment 25.7 26.2
(as a % of GDP) 1.5 1.4

Total managed 741.5 763.4
 expenditure
(as a % of GDP) 42.8 42.2

Public sector net 76.6 64.7
 borrowing
(as a % of GDP) 4.4 3.6

Financial transactions -6.0 -7.0
Public sector net cash 82.6 71.7
 requirement
(as a % of GDP) 4.8 4.0
Public sector net debt 76.9 77.4
 (% of GDP)

GDP deflator at market 121.2 123.6
 prices (2006=100)
Money GDP 1732.0 1809.9

Financial balance under Maastricht -4.8 -3.8
 (% of GDP) (b)
Gross debt under Maastricht (% of GDP) (b) 89.6 89.4

Notes: These data are constructed from seasonally adjusted
national accounts data This results in differences between the
figures here and unadjusted fiscal year data. Data exclude the
impact of financial sector interventions. (a) Public sector
current budget surplus is total current receipts less total
current expenditure and depreciation. (b) Calendar year.

Table A9. Accumulation

As a percentage of GDP

 Households Companies General government

 Saving Investment Saving Investment Saving Investment

2005 2.7 5.3 12.8 10.1 -1.1 1.7
2006 2.3 5.6 12.0 10.2 -0.2 1.7
2007 1.7 5.8 14.3 10.8 -0.4 1.6
2008 1.3 4.6 15.0 9.8 -1.3 2.2
2009 4.2 3.4 13.9 7.4 -6.3 2.6
2010 3.7 3.5 14.7 9.1 -6.6 2.5
2011 35 3.4 14.5 8.6 -5.6 2.1
2012 4.3 3.6 13.9 8.7 -4.8 1.7
2013 4.8 3.9 13.0 8.7 -3.6 1.5
2014 5.1 4.3 12.2 8.7 -2.3 1.4
2015 5.3 4.7 11.5 8.8 -1.4 1.3

 Finance from abroad
 Whole economy Net
 Total Net factor national
 Saving Investment income (a) saving

2005 14.5 17.1 2.6 -1.8 3.4
2006 14.1 17.5 3.4 -0.7 3.0
2007 15.6 18.2 2.6 -1.5 4.6
2008 15.0 16.7 1.6 -2.0 4.6
2009 11.8 13.5 1.7 -1.5 0.8
2010 11.8 15.0 3.2 -1.6 1.1
2011 12.4 14.2 1.8 -2.3 1.7
2012 13.3 14.0 0.7 -2.2 2.6
2013 14.2 14.1 -0.1 -1.9 3.5
2014 15.0 14.4 -0.6 -1.5 4.3
2015 15.5 14.8 -0.7 -1.2 4.8

Note: (a) Negative sign indicates a surplus for the UK.

Table A10. Long-term projections

All figures percentage change unless otherwise stated

 2007 2008 2009 2010 2011

GDP (market prices) 2.7 -0.1 -4.9 1.4 1.3
Average earnings 5.0 1.5 2.6 3.3 2.0
GDP deflator (market prices) 3.0 3.0 1.4 2.9 3.2
Consumer Prices Index 2.3 3.6 2.2 3.3 4.2
Per capita GDP 2.0 -0.7 -5.5 0.6 0.6
Whole economy productivity(a) 1.9 -0.5 -1.8 1.0 1.0
Labour input(b) 0.8 0.4 -2.9 0.5 0.4
ILO unemployment rate (%) 5.4 5.7 7.6 7.9 7.9
Current account (% of GDP) -2.6 -1.6 -1.7 -3.2 -1.8
Total managed expenditure
 (% of GDP) 40.8 42.6 47.4 47.4 46.5
Public sector net borrowing
 (% of GDP) 2.5 4.6 10.8 10.1 8.8
Public sector net debt
 (% of GDP) 36.7 38.7 47.9 56.3 62.7
Effective exchange rate
 (2005= 100) 102.9 90.7 81.2 81.0 80.3
Bank Rate (%) 5.5 4.7 0.6 0.5 0.5
3 month interest rates (%) 6.0 5.5 1.2 0.7 0.8
10 year interest rates (%) 5.0 4.5 3.7 3.6 3.4

 2012 2013 2014 2015 2016-20

GDP (market prices) 2.0 2.3 2.4 2.4 2.5
Average earnings 3.2 3.1 2.9 3.1 3.5
GDP deflator (market prices) 1.5 1.8 2.1 2.0 2.0
Consumer Prices Index 1.9 1.8 1.9 2.0 2.0
Per capita GDP 1.4 1.7 1.8 1.8 1.8
Whole economy productivity(a) 1.3 0.9 0.8 1.2 2.1
Labour input(b) 0.8 1.4 1.6 1.2 0.3
ILO unemployment rate (%) 8.3 7.8 6.9 6.4 6.2
Current account (% of GDP) -0.7 0.1 0.6 0.7 0.5
Total managed expenditure
 (% of GDP) 45.5 44.3 43.1 42.3 41.4
Public sector net borrowing
 (% of GDP) 7.6 6.1 4.7 3.8 2.4
Public sector net debt
 (% of GDP) 68.9 73.4 76.0 77.1 75.4
Effective exchange rate
 (2005= 100) 79.9 80.9 82.1 83.2 85.7
Bank Rate (%) 0.6 0.9 1.5 2.3 3.6
3 month interest rates (%) 0.7 1.0 1.6 2.3 3.7
10 year interest rates (%) 3.3 3.6 3.9 4.2 4.7

Notes:
(a) Per hour.

(b) Total hours worked.

Acknowledgements

The forecast was completed using the latest version of the National Institute Global Econometric Model (NIGEM). Thanks to Dawn Holland and Jonathan Portes for helpful comments and suggestions.

The forecast was completed on 26 July 2011.

REFERENCES

Barrell, R. and Holland, D. (2010), 'Fiscal and financial responses to the economic downturn', National Institute Economic Review, 211, pp. R51-62.

Barrell, R., Kirby, S. and Orazgani, A. (2011), 'The macroeconomic impact from extending working lives', Department for Work and Pensions Economics Paper no. 95.

Bell, D. and Blanchflower, D. (2010), 'UK unemployment in the Great Recession', National Institute Economic Review, 214, pp. R3-25.

Holland, D., Kirby, S. and Whitworth, R. (2010), 'A comparison of labour market responses in the global downturn', National Institute Economic Review, 211, pp. F38-42.

Migration Advisory Committee (2010) limits on Migration: Limits on Tier I and Tier 2 for 2011/12 and supporting policies.

NOTES

(1) The ONS has suggested that one-off events subtracted as much as 0.5 percentage points from the rate of growth in the second quarter of 2011, suggesting underlying growth was closer to 0.7 per cent per quarter. Given that the preliminary estimate of GDP is based on only 40 per cent data with the rest 'nowcast' by the ONS we should be cautious with such an estimate. If this estimate of underlying growth proves to be accurate this would point to a significantly more buoyant recovery than forecast.

(2) Compared with our April forecast this is a downward revision of 0.1 percentage point for this year and no change for 2012.

(3) June 2011 marked 21 months since the end of the recession. The rate of economic expansion to date has been the slowest of any post-recession period in around 75 years.

(4) The Bank notes that adequate data on forbearance are not currently collected.

(5) Figure 4 reports the 80, 85 and 90 per cent confidence intervals around our forecast for CPI inflation. These bounds are derived from stochastic simulations using NiGEM.

(6) The OBR's latest estimate of the output gap (published in the Economic and Fiscal Outlook, March 2011, is 3 per cent.

(7) The Chancellor authorised that up to 50 billion [pounds sterling] of the APF could be used for private sector assets and that the Bank can continue to transact commercial assets in order to maintain the size of the APF. However, the Bank's Asset Purchase Facility Report for the second quarter of this year reports that the Bank has continued with net sales of corporate bonds, such that the outstanding stock of corporate bonds stood at a little over 1.1 billion [pounds sterling], down from 1.6 billion [pounds sterling] at the end of the second quarter of 2010. Corporate bonds now account for just over 1/2 per cent of the 199 billion [pounds sterling] in asset purchases on the Bank's balance sheet.

(8) We also expect the secondary target of reducing net public sector debt as a per cent of GDP in 2015-16 to be missed.

(9) See Bell and Blanchflower (2010) for a discussion of the scars from youth unemployment.

(10) The fiscal tightening required is an illustration. The OBR states that a 0.5 per cent of GDP tightening in each decade would achieve the same target, but with a higher public sector net debt to GDP ratio in the years close to 2016-17.

(11) In other words, stable low real wage growth over the next few years is necessary to ensure the continuation of labour hoarding.

(12) The major contributor to allowing employers to 'hoard' labour was the sharp reduction in real wages (see Holland et al., 2010).

(13) It is likely that the drop in hours worked is also due to people using annual leave to take advantage of the additional bank holiday. To this end we should expect a bounce bank in hours worked in the third quarter of this year by more than might at first be expected.

(14) These calculations are based on the June 2011 vintage of US National Accounts.

(15) A third scenario is where firms are not hoarding labour because the UK economy going forward is less productive than experienced in the recent past. The effect of this lower labour productivity is to reduce trend growth in the economy. Given our forecast for demand over the next few years, this would imply a far sharper closing of the output gap. This has significant policy implications; the structural deficit would be far larger than currently estimated, necessitating tighter fiscal policy in order to get the structurally adjusted deficit back on target. With significantly less spare capacity to put downward pressure on the price increases, monetary policy would need to be tightened more aggressively than currently expected.

(16) See remarks by the Chancellor of the Exchequer, Rt Hon George Osborne MP, at the International Monetary Fund (IMF) Article IV concluding statement: http://www.hmtreasury.gov.uk/ speech_chx_060611.htm.

(17) See http://www.imf.org/external/np/ms/2011/060611.htm.

(18) The sale of the 'good bank' part of Northern Rock was announced by the Chancellor in his Mansion House speech: http://www.hm-treasury.gov.uk/press_58_11.htm.

(19) This is on an annual average basis. The current account is volatile. On a quarterly basis the UK current account was last in surplus in the third quarter of 1997.

(20) Planning reform currently being introduced by the government poses an upside risk to both the housing and business investment forecasts.

(21) Treasury estimates, reported in Migration Advisory Committee (2010) suggest that a reduction in annual skilled migration of 50,000 would reduce trend growth by slightly less than 0.2 per cent: http://www.ukba.homeoffice.gov.uk/ sitecontent/documents/aboutus/workingwithus/mac/maclimits-t1-t2/ report.pdf?view=Binary.

(22) For example, a comprehensive programme of research by economists at NIESR and elsewhere has consistently failed to find any significant negative impacts of the National Minimum Wage.

doi: 10.1177/0027950111420950

Table 1. Summary of the forecast Percentage change

 2007 2008 2009 2010

GDP 2.7 -0.1 -4.9 1.4
Per capita GDP 2.0 -0.7 -5.5 0.6

CPI Inflation 2.3 3.6 2.2 3.3
RPIX Inflation 3.2 4.3 2.0 4.8

RPDI 0.4 1.1 1.2 -0.8

Unemployment, % 5.4 5.7 7.6 7.9
Bank Rate, % 5.5 4.7 0.6 0.5
Long Rates, % 5.0 4.5 3.7 3.6
Effective exchange rate 2.1 -11.9 -10.5 -0.2

Current account as % of GDP -2.6 -1.6 -1.7 -3.2

PSN B as % of G DP (a) 2.3 6.8 11.0 9.6
PSND as % of GDP (a) 36.4 43.4 53.0 60.3

 2011 2012 2013 2014

GDP 1.3 2.0 2.3 2.4
Per capita GDP 0.6 1.4 1.7 1.8

CPI Inflation 4.2 1.9 1.8 1.9
RPIX Inflation 5.0 2.3 2.2 2.5

RPDI -1.1 1.8 2.3 2.4

Unemployment, % 7.9 8.3 7.8 6.9
Bank Rate, % 0.5 0.6 0.9 1.5
Long Rates, % 3.4 3.3 3.6 3.9
Effective exchange rate -0.9 -0.5 1.3 1.5

Current account as % of GDP -1.8 -0.7 0.1 0.6

PSN B as % of G DP (a) 8.6 7.3 5.8 4.4
PSND as % of GDP (a) 66.7 72.0 75.3 76.9

 2015

GDP 2.4
Per capita GDP 1.8

CPI Inflation 2.0
RPIX Inflation 2.5

RPDI 2.7

Unemployment, % 6.4
Bank Rate, % 2.3
Long Rates, % 4.2
Effective exchange rate 1.3

Current account as % of GDP 0.7

PSN B as % of G DP (a) 3.6
PSND as % of GDP (a) 77.4

Notes: RPDI is real personal disposable income. PSNB is public sector
net borrowing. PSND is public sector net debt (a) Fiscal year,
excludes the impact of financial sector interventions.