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Current market data is disappointing and puzzling

Rebalancing the economy and fiscal austerity come at a price as we are likely to see a long-term picture of modest trend growth and a subdued consumer

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The economic data released in recent months has been disappointing and puzzling in the same measure.

The first half GDP 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 employment data or business surveys. If you put greater weight on the recent employment data and surveys you need to explain the UK’s resulting abysmal productivity performance which will have a major bearing on the likely long term growth performance of the UK economy.

There are already clear signs that underlying trend UK growth is much nearer 2 per cent than 2.25 per cent or 2.5 per cent.

The chart below shows UK growth back to 1870 based on Feinstein and the National Accounts. The UK’s very long-term growth rate is just under 2 per cent and just above 2 per cent since the War. Barring any major economic productivity gains perhaps this is what we can expect in the next 10 years, 2 per cent growth rather than 2.5 per cent+.

Our latest central economic forecasts are shown below in summary terms. GDP output is expected to fall by 0.2 per cent this year before growing by around 0.7 per cent in 2013. The economy is not expected to return to 2008 peak until 2015/16 at the earliest. Modest trend growth and a very subdued consumer are likely too be a long term feature of the UK economy, rebalancing the economy and fiscal austerity comes at a price.

Real household income growth has been heavily squeezed in recent years as inflation has eroded the value of disposable incomes. Lower inflation should help to boost real incomes but only by around 0.7 per cent in 2013. In the medium term real income growth should return to around 2 per cent which is consistent with 4 per cent nominal wage growth. Bank Rate is likely to remain at 0.5 per cent 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 very weak market. However, these spreads are unlikely to prove sustainable in the long term once Bank Rate finally returns to more normal levels.

We continue to expect house prices to fall by around 3 per cent this year before stabilising in 2013/14. 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 the course of 2013 and unemployment is seen to have peaked we are likely to experience a gradual return to very modest house price growth.

Mortgage lending is likely to remain broadly flat for the next two years as lenders concentrate on re-shaping balance sheets and restoring margins further. We expect gross mortgage lending to get back to £150bn by 2016, still less than half of the 2007 peak level.

The most sobering lesson is to look back at the forecasts of recent years and realise the true extent of expectation revision. The table below shows the forecast record for three key variables since the start of 2011. GDP growth forecasts for the current year have been revised down from 2.2 per cent in January 2011 to -0.2 per cent in the current version. But it is the revision in the gross lending forecasts that is most startling with lending forecasts of £149bn reduced to £134bn in the current year.

Perhaps looking further ahead than 2012 is beyond all of us in the current climate.

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