Rebalancing the economy comes at a price
Economic data released in recent months has been disappointing to say the least. Q1 gross domestic product figures put the UK back into recession along with several other European economies. The economic optimists keep dismissing the official output data and choose to emphasise the more upbeat business surveys.
But what is becoming increasingly clear is that any recovery is going to be weak and protracted whatever data is referred to.
The direct impact of deleveraging in the consumer and banking sectors will result in persistently lower economic growth than we are used to and that perhaps will become a semi-permanent feature of the UK economy.
Based on data since 1870, the UK’s long-term growth rate is just under 2% and just above 2% since World War II. Barring major economic productivity gains perhaps 2% growth is what we can expect in the next 10 years rather than 2.5%-plus.
Our latest central economic forecasts are shown below. GDP growth is expected to be around 0.6% to 0.7% in 2012 and 2013. The economy is not expected to return to its 2008 peak until 2015 at the earliest. Modest trend growth and a subdued consumer appetite are likely to be a long-term feature; rebalancing the UK economy comes at a price.
Real household income growth has been heavily squeezed in the past two years as inflation has eroded the value of disposable incomes.
Lower inflation in 2012 and 2013 should help boost real incomes to only around 0.7% in 2013. In the medium term real income growth should return to around 2% which is consistent with 4% nominal wage growth.
“Real household income growth has been squeezed as inflation has eroded the value of disposable incomes”
The Bank of England base rate is likely to remain at 0.5% until 2015 unless we see a sharp improvement in the economy.
We have assumed mortgage spreads continue to widen as banks attempt to maintain margins in a weak market. But this is unlikely to prove sustainable in the long term once the base rate returns to more normal levels. We expect house prices to fall by around 3% this year before stabilising in 2013.
Low transaction volumes, limited mortgage availability, weak real income growth and low consumer confidence all have their part to play. As the economy firms during 2013 and unemployment is seen to have peaked, we are likely to experience a gradual return to modest house price growth.
Mortgage lending is likely to remain broadly flat for the next two years as lenders concentrate on reshaping balance sheets and restoring margins further. We expect gross mortgage lending to get back to £165bn by 2016, still less than half of the 2007 peak.
Our central forecast only has a probability of 40% - unusually low for this stage of the cycle. The spectre of even faster deleveraging or a sharp correction in the euro area are the biggest downside risks to the economy. In addition, the possibility of a 50% increase in oil prices needs to be factored into any assessment of prospects.
The table above highlights the likely impact of faster deleveraging in the UK on our main markets. Under this scenario banks and consumers accelerate the rate of deleveraging and as a result GDP growth remains well below 2% for the whole of the forecasting period.
Gross mortgage lending eases back to around £130bn and the housing market flat lines for the foreseeable future.
High levels of arrears are likely to be stubbornly persistent in this scenario and repossessions are expected to return to above 40,000 a year.