1 ACE Sheffield 25 April 2012 The UK Economy and the next five years Roger Martin-Fagg Behavioural Economist

We need 7% growth in Broad money for normal growth a : broad money is the liabilities of UK banks and building societies b : nominal GDP is what flows out of our economic pipe, it is adjusted for inflation to determine real growth

UK Broad money and bank credit: Banks are destroying money 7% Required for normal growth

Sources: ECB, Thomson Reuters Datastream and Bank calculations. (a)Households’ gross debt as a percentage of a four-quarter moving sum of their disposable income. Household debt relative to income: Retail will continue to struggle until the UK gets back to 110

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6 UK Retail Sales are broadly flat In final three months of 2011, volume up 1.4%, value up 5.4%

Sources: ECB, ONS and Bank calculations. Income gearing is measured as household interest payments as a percentage of disposable income. UK Household income gearing: interest rates will be 0.5% until 2015

10 Non-discretionary spending is now 67.3% of household disposable income ( in 2001 it was 56.6%) The average mortgage rate is 3.43%. 18% of household disposable income is used to finance their mortgage (22% in 2008) Household spending is 60% of GDP. Last year it contracted by 1.7%. This year is no better. Unless oil and food prices fall by 20% or wages rise 7% each year over the next two years, the UK will go into recession this Quarter and then stagnate with GDP growing less than 1% pa for the next 4 years. Interest rates will remain at 0.5% for at least another 3 years. The UK Outlook

11 Which sectors in the UK will grow more strongly over the next 5 years ? Export facing manufacturing eg motor vehicles, oil industry equipment, high design content bespoke equipment regardless of sector. Medical technology and pharma Distinctive, niche fashion not necessarily high end New media, gaming, music and drama The underperformers Financial services Mass undifferentiated retail including eating out Poundland New build Construction but not repair and maintenance M&S

Economic growth and the Real Price of Oil Growth BoomGrowth Iranian revolution OPEC cuts production End of Iranian hostage crisis OPEC cartel collapses Invasion of Kuwait Start of second war in Iraq Stag- flation Constant US$ per barrel Source: International Monetary Fund Average growth rate in real GDP, : 3.7% RECESSIOnRECESSIOn RECESSIOnRECESSIOn Percent % Real Price of Oil World real economic growth Forecast From 2012 onwards floor price $100

§ Eurozone growth in Bank Lending : the October ‘rescue’ plan will reduce this to -2% over the next two years. Probability of a recession? 100% Source:ECB

14 In the EU the rate of growth in retail sales has been declining at 1.5% per annum since 2008

Credit growth is driving the US recovery

Conclusions:rest of world China will slow to 7% growth from the current 9.8%, as the property market bubble bursts and export volumes grow more slowly Brazil is slowing rapidly as their domestic credit boom ends and bad debt increases. Next year they will only grow by 2% and in 2013 they will only just avoid outright recession ( due to the European recession and Chinese slow down) India will deliver 7% each year year driven by domestic demand and continued outsourcing of services by the West The Global GDP growth rate will drop from 4.5% to 2% in 2012, and 1.5% in So not as bad as , but still very challenging. The good news is companies have lots of cash: all you need to do is give them a compelling reason to spend it with you!

Europe will shrink by 1.5% in 2012 and by 2.8% in 2013, the contraction will be greater in the periphery than core. Greece will default and leave the Euro, some French and German banks will be rescued by Government. By the end of 2013 it will be agreed that the Euro in its current form cannot survive ( Italy and Spain need a devaluation). The UK will contract by 1% in 2012, and grow by less than 1% in 2013 The USA will at best grow by 1.8% in 2012, with a 50% chance of recession in 2013 There will be a severe credit crunch in Eastern Europe with a sharp increase in the number of insolvencies, even Poland will come close to recession, whilst Hungary will contract by 5% Russia will slow in 2012 as the price of oil falls towards $100 and stays there for 2 years. This will weaken the rouble by 10% and increase political tensions as GDP growth slows to 2%

Key Points The UK is experiencing a once in a lifetime discontinuity, not the normal economic cycle Over-indebted households will continue to pay down debt for another 5 years All the traditional consumer demand forecasting models are hopeless, bin them, this is not like the past : repeating the old business model will not work Innovate or die There is very little Government can do except keep interest rates as low as possible Sales growth greater than 3% pa will require an increase in market share unless exporting.