Summer takes heat out of the economy
The impact of recent events in the world's financial markets will take the heat out of the UK economy, our panel of leading analysts say.
On this page:
Inflation: CPI falls back but headline measure is on the rise
Outlook for inflation
Growth: expansion to continue, albeit more slowly
Outlook for growth
Labour market: mixed signals
Outlook for labour
market
Table: Forecast of annual rate
of change in retail prices and earnings, 2007/08
|
Key points
|
The latest commentary from forecaster RBS says it has "been a summer to remember" for the British economy, if not for its tourist industry. The floods that engulfed England were followed by a deluge in the UK financial markets when instability triggered by defaults on injudicious mortgage loans in the US sent shock waves around the world.
The impact has yet to work its into the UK's official economic data. However, some of the effects are already being felt - the October 2007 meeting of the Bank of England's monetary policy committee (MPC) voted to keep interest rates on hold at 5.75% when, only a few weeks before, there were indications that a further increase was on the cards, following July's 0.25 base point rise. Now, talk is of a cut. Furthermore, as the availability of credit is being squeezed, growth forecasts are being pared back, and there is even the suggestion that the government's preferred measure of inflation - the consumer prices index (CPI) - may consistently undershoot the 2% target, only months after it exceeded the 3% mark, the level at which the governor of the Bank of England (BoE) was required to write an explanatory letter to the then chancellor, Gordon Brown.
We assess the outlook for the UK economy, based on the views of our panel of 10 leading economic forecasters. We cover the key areas of inflation, economic growth, and the labour market.
Inflation: CPI falls back but headline measure remains on the high side
Over the 12 months to September 2007, CPI inflation was pitched at 1.8%, unchanged from the August figure. The CPI remains at its lowest level since March 2006 - in sharp contrast with the situation six months ago when it stood at 3.1%. The recent decline is largely a reflection of last year's hikes in utility prices falling out of the year-on-year figures, together with the impact of more recent cuts in gas and electricity tariffs.
While the latest fall in the CPI was generally interpreted as good news for the Bank, there was a larger-than-expected rise in the all-items retail prices index (RPI) in August. According to this yardstick, commonly known as the "headline" rate and still the figure predominantly used by pay setters, inflation over the year to 31 August 2007 stood at 4.1%, compared with 3.8% in July. One of the key reasons for this was the rise in mortgage interest payments following July's 0.25% rise in interest rates. However, the latest figures show that RPI has fallen back slightly, to 3.9% in September.
Forecasters warn that upward price pressures remain in the pipeline - notably in the form of higher petrol and food prices. Nevertheless, as RBS points out, "the starting point of [CPI inflation at] 1.8% gives the MPC some leeway" when it comes to deciding what to do about interest rates.
Outlook for inflation
The view not only of the BoE but also of our panel of 10 leading City and academic institutions is that recent events are likely to take some heat out of the UK economy. Combined with recent rises in interest rates (three in 2007) this should make it easier for the government to meet and, possibly, undershoot its 2% CPI inflation target during the remainder of 2007. “Recent CPI inflation has surprised on the downside due to a larger-than-expected fall in goods price inflation, and we have lowered our forecast for the next few quarters,” says the CBI.
As the table below indicates, the predicted outlook for RPI inflation is a little more mixed, although it should be noted that a number of forecasts were published before the latest bout of economic turbulence. Of those available at the time of writing, Oxford Economics expects headline RPI to come in at 3.7% in the first quarter of 2008, falling markedly to just 1.7% in the fourth quarter of next year. This latter figure is 0.2 percentage points below its CPI forecast for the same period. UBS is less optimistic in its assessment. Headline inflation will stand at 3.9% in the fourth quarter of this year, it says, declining modestly to 3.8% in the first quarter of 2008. It is projected to ease at a sedate pace, settling at 3.2% in the final quarter of next year.
The consensus view is that headline inflation has probably peaked, and will decline during the course of 2008. This is reflected in the PABB unweighted average of analysts' predictions, which suggests that the RPI will ease back to 2.6% by the fourth quarter of next year, compared with the 3.9% that is projected for the fourth quarter of 2007.
Growth: expansion to continue, albeit more slowly
The UK economy has continued to grow, with gross domestic product (GDP) increasing by 0.8% in the second quarter of 2007 - an improvement of 0.1 percentage points on the previous quarter, and an impressive 3.1% higher than the second quarter of 2006 - giving at least some credence to the government's insistence that the economy's "fundamentals" remain sound, despite recent market shocks.
The second quarter data set for 2007 from the Office for National Statistics (ONS) reveals that growth was sustained across all industries. Production rose by 0.7%, driven by both manufacturing, and oil and gas extraction (up 0.8% and 1.3% respectively), while services grew by 0.9%, within which the business services and finances industries grew by 1.7% and activity in the transport, storage and communication industries expanded by 0.8%.
Yet there are some signs that, while the UK economy is not heading for the buffers, a slowdown may be in the offing. This is no surprise, given a tightening in monetary policy and squeeze on the availability of credit.
Outlook for growth
Several forecasters have trimmed their growth projections in light of recent events. Lehman Brothers has revised down its GDP forecast for 2008 from 2.3% to 1.7%. HSBC Global Research also thinks that the UK economy will expand by just 1.7% next year, down from the 2% previously predicted. The CBI has downgraded its estimate for 2008, "reflecting a weaker outlook for overseas demand, and a modest downgrade to consumer spending". Thus, GDP is forecast to grow by 2.2%, which is 0.2% lower than its previous forecast.
Analysts whose projections were issued before the late summer market turmoil were also predicting that the rate of expansion would ease. "Looking forward, we would expect higher interest rates to lead to a slowdown in growth. GDP is expected to rise by 2.8% this year, but only 2.4% in 2008," says Oxford Economics. The National Institute of Economic and Social Research thinks that growth will be pitched at 2.8% in 2007, moderating to 2.6% in 2008.
Labour market: mixed signals
As several commentators point out, the UK labour market continues to give mixed signals. Pay pressures appear muted - the IRS headline measure of wage settlements stood at 3.3% during the three months to the end of September 2007, down from the August figure. The headline ONS measure of average earnings growth moved up slightly to 3.7% over the three months to August 2007, up from 3.5% in July. However, while private sector average earnings are on the rise (reaching 4% in August, up from 3.7% in July), there has been a marked easing in the public sector over the past few months, with earnings growth standing at 2.9% in August. Excluding bonuses, average earnings increased by 3.7%, year on year.
The relatively stable pay environment is set against a background of falling unemployment. According to the ONS, the unemployment rate was 5.4% in the three months to August 2007, unchanged from the previous quarter. The number of people in work is on the rise, with much of the fall in the jobless figure attributed to a rise in employment of 22,000. Two possible explanations for this apparent paradox - low and falling unemployment and static pay settlements - are advanced in the minutes of the MPC's September 2007 meeting. First, migrant workers may be helping to hold down wage levels, particularly for lower-paid jobs. Second, the MPC points out that higher non-wage costs may have prompted employers to seek a downward adjustment in real wages.
Outlook for the labour market
Even before the turmoil in the markets this summer, there was little sign of the imminent pay explosion that some had feared in response to higher inflation, and there is scant reason to expect any radical change - especially if growth slackens, and unemployment rises. As RBS points out, "not only has the 2007 bonus seasons failed to ignite wage inflation, but average earnings growth has even declined over the first quarter…Generally tight labour market conditions will probably prevent any further significant easing in wage settlements, but expectations of slower economic growth next year will cap the upside."
According to our forecast panel, whole economy average earnings will increase by an average of 3.9% in the fourth quarter of 2007. In the first quarter of 2008, average earning growth will moderate somewhat before picking up again. It is predicted to be at or around the 4% mark for the remainder of 2008.
|
Table: Forecast of annual rate of change in retail prices and earnings, 2007/081 | ||||||||
|
|
2007 |
2008 | ||||||
|
Retail prices |
Q3 |
Q4 |
Year |
Q1 |
Q2 |
Q3 |
Q4 |
Year |
|
Barclays Capital |
4.1% |
4.0% |
4.2% |
3.1% |
2.7% |
2.4% |
2.3% |
2.6% |
|
CBI |
4.2% |
4.1% |
4.3% |
3.6% |
3.6% |
3.2% |
2.9% |
3.4% |
|
CSFB |
4.3% |
4.3% |
4.4% |
3.9% |
3.4% |
2.9% |
2.8% |
3.2% |
|
Goldman Sachs |
3.8% |
3.6% |
4.3% |
3.1% |
2.7% |
2.8% |
2.6% |
3.1% |
|
HSBC Bank |
3.9% |
3.7% |
4.1% |
3.1% |
2.5% |
2.2% |
2.1% |
2.5% |
|
Lehman Brothers |
3.9% |
3.9% |
4.2% |
3.8% |
3.8% |
3.9% |
3.6% |
3.8% |
|
NIESR |
- |
- |
4.2% |
- |
- |
- |
- |
3.4% |
|
Oxford Economics |
4.0% |
4.0% |
4.2% |
3.7% |
3.1% |
2.4% |
1.7% |
2.7% |
|
Royal Bank of Scotland |
3.9% |
3.8% |
4.1% |
3.5% |
3.4% |
3.3% |
2.9% |
3.3% |
|
UBS |
3.9% |
3.9% |
4.2% |
3.8% |
3.6% |
3.6% |
3.2% |
3.6% |
|
PABB average2 |
4.0% |
3.9% |
4.2% |
3.5% |
3.2% |
2.9% |
2.6% |
3.2% |
|
Range of forecasts |
3.8%-4.3% |
3.6%-4.3% |
4.1%-4.4% |
3.1%-3.9% |
2.7%-3.8% |
2.2%- 3.9% |
1.7%-3.6% |
2.5%-3.8% |
|
|
2007 |
2008 | ||||||
|
Earnings, whole-economy |
Q3 |
Q4 |
Year |
Q1 |
Q2 |
Q3 |
Q4 |
Year |
|
Barclays Capital |
3.2% |
3.2% |
3.5% |
2.8% |
3.7% |
3.7% |
3.6% |
3.5% |
|
CBI |
4.0% |
4.1% |
4.0% |
3.4% |
4.4% |
4.0% |
4.1% |
3.9% |
|
CSFB |
4.4% |
4.4% |
4.4% |
4.4% |
4.4% |
4.4% |
4.4% |
4.4% |
|
Goldman Sachs |
3.8% |
4.2% |
4.0% |
3.9% |
4.9% |
4.4% |
4.5% |
4.4% |
|
HSBC Bank |
3.5% |
3.6% |
3.8% |
3.0% |
3.2% |
3.4% |
3.5% |
3.3% |
|
Lehman Brothers |
4.0% |
3.9% |
4.0% |
3.5% |
3.9% |
3.9% |
3.9% |
3.8% |
|
NIESR |
- |
- |
3.6%3 |
- |
- |
- |
- |
4.4%3 |
|
Oxford Economics |
4.2% |
4.2% |
4.2% |
4.2% |
4.3% |
4.3% |
4.3% |
4.2% |
|
Royal Bank of Scotland |
3.9% |
4.1% |
4.0% |
4.1% |
4.1% |
4.1% |
4.1% |
4.1% |
|
UBS |
3.6% |
3.6% |
3.6% |
3.7% |
3.9% |
4.1% |
4.3% |
4.3% |
|
PABB average2 |
3.8% |
3.9% |
3.9% |
3.7% |
4.1% |
4.0% |
4.1% |
4.0% |
|
Range of forecasts |
3.2%-4.4% |
3.2%-4.4% |
3.5%-4.4% |
2.8%-4.4% |
3.2%-4.9% |
3.7%-4.4% |
3.5%-4.5% |
3.3%-4.4% |
|
1. Based on the latest figures available on 4 October 2007: CBI - September 2007; Goldman Sachs - August 2007; Oxford Economic Forecasting - July 2007; NIESR - July 2007. 2. Pay and Benefits Bulletin average: unweighted average of the analysts' predictions. 3. Based on National Accounts data, which is defined as employee compensation per employee job, taking into account items such as pensions costs and national insurance contributions. Source: Individual forecasting organisations. | ||||||||
