Alan WilsonOxford Economics November 2008

The macroeconomic environment

2

The macroeconomic environment – a summary

3

Key issues

The global background

How severe a recession in the UK?

What structural changes are taking place?

Implications for the regional pattern of growth

The Global Background

5

Rising waves of financial stress

-10

-5

0

5

10

15

20

25

30

35

40

45

2004 2005 2006 2007 2008Source: Oxford Economics

US: Financial stress indicator

high stress

low stress

Credit crunch starts

End-year liquidity squeeze

Bear Stearns' rescue

Fannie Mae & Freddie Mac support

Lehmans' collapse, Paulson plan

6

At the same time, price rises were squeezing incomes

10

30

50

70

90

110

130

150

170

2000 2001 2002 2003 2004 2005 2006 2007 2008

80

100

120

140

160

180

200

220

240

260

280

Source: Haver Analytics

World: Commodity prices$/barrel 2000 Week 1=100

Brent oil(LHS)

Economist ($)commodity price

index (RHS)

7

2009 set to be a very tough year

-3

-2

-1

0

1

2

3

4

5

1990 1993 1996 1999 2002 2005 2008 2011Source: Oxford Economics

% yearUK

US

World: GDP growth

Eurozone

Forecast

8

Forecast summary

2007 2008 2009 2010 2011 2012

US 2.0 1.3 -0.4 2.5 3.6 3.8

Japan 2.0 0.5 -1.1 0.6 1.5 2.0

Eurozone 2.6 1.0 -0.5 1.2 2.0 2.3

of which:

Germany 2.6 1.3 -0.7 1.1 1.8 2.3

France 2.1 0.9 -0.3 1.2 1.9 2.2

Italy 1.4 -0.4 -0.8 0.5 1.3 1.7

UK 3.0 0.8 -1.0 0.9 2.6 3.3

South Korea 5.0 4.1 1.5 4.2 5.6 5.4

China 11.9 9.2 8.4 8.7 8.9 9.2

Other Asia 6.0 3.4 1.6 4.4 5.3 5.2

Mexico 3.2 2.0 0.4 2.1 4.6 4.9

Other Latin America 6.2 5.3 2.5 3.4 4.2 3.9

Eastern Europe 7.3 6.3 3.6 4.4 5.3 5.5

World 3.8 2.4 1.0 2.9 4.0 4.2

World (PPP) 4.8 3.6 2.1 3.7 4.6 4.8

World GDP Growth% Change on Previous Year

9

Will policy help? – co-ordinated rate cuts

0

1

2

3

4

5

6

7

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008Source: Haver Analytics

US Federal funds target rate

ECB repo rate

UK repo rate

Official interest rates%

10

Fiscal policy to support demand

-10

-8

-6

-4

-2

0

2

4

1986 1990 1994 1998 2002 2006 2010Source: Oxford Economics

% of GDP

UK

US

Eurozone

World: Public sector deficits

Forecast

11

Medium-term challenge of rebuilding household balance sheets cannot be avoided

-2

0

2

4

6

8

10

12

14

16

1980 1983 1986 1989 1992 1995 1998 2001 2004 2007

World: household savings ratiosSavings rate, %

Source : Oxford Economics/Haver Analytics

Eurozone big-4

UK

US

The UK Forecast

13

Oxford Economics’ latest UK forecast

% September baseline forecast

September extended credit

crunch

November baseline forecast

GDP growth

2008

2009

2010

1.2

0.5

2.2

0.9

-1.0

0.3

0.8

-1.0

0.9

CPI inflation

2008

2009

2010

3.8

3.0

1.8

3.5

2.1

1.0

3.8

2.3

1.2

Bank rate 2008

2009

2010

5.8

4.6

4.2

5.5

4.0

3.0

4.6

2.0

2.1

Probability 50% 35% ?

14

Libor spreads widened post-Lehmans…

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

Jul-07

Sep-07

Nov-07

Jan-08

Mar-08

May-08

Jul-08

Sep-08

Nov-08

Source : Haver Analytics

%

UK: LIBOR spread

3-month LIBOR

Bank rate

15

…and companies starting to feel the pinch

16

House price falls show no sign of slowing…

17

…and equity market sharply lower…

18

…with household wealth losses over £1.3trn

19

…and huge fall in confidence

-40

-35

-30

-25

-20

-15

-10

-5

0

5

10

1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Source: Haver Analytics

GfK NOP Index

UK: Consumer confidence

20

Blue Book shows even lower saving ratio…

-2

0

2

4

6

8

10

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

UK: Savings ratio%

Source : Oxford Economics/Haver Analytics

Now

Previous

21

…and huge swing needed in financial balance

22

UK companies better-placed than rest of EU…

23

…but GDP down more than expected in Q3…

24

…order books collapsing…

25

…and investment intentions cut back sharply

26

Policy stance has changed dramatically…

Bank rescue plan:

■ £50 billion to recapitalise UK banks, with £37 billion from government.

■ A new government-backed company to guarantee new short and medium-term debt issues by banks with maturities up to three years for use in refinancing maturing interbank borrowings. The government expects the take-up of the guarantee to be of the order of £250 billion.

■ The Special Liquidity Scheme (SLS) has also been doubled to £200 billion.

Cuts in interest rates – down 200bp in two months

Prospect of fiscal action:

■ Accelerating government investment

■ Tax cuts to be announced in the PBR - £10 billion?

27

Tax cuts key to easing saving correction…

28

…which is key uncertainty in forecast

29

Implications of alternative saving ratios

% 5% saving ratio

(November baseline)

7% saving ratio 9% saving ratio

GDP growth

2009

2010

-1.0

0.9

-1.6

0.1

-2.5

-0.2

CPI inflation

2009

2010

2.3

1.2

2.0

0.7

1.5

0.1

Bank rate 2009

2010

2.0

2.1

1.4

0.7

0.7

0.3

30

Oxford Economics’ forecast

2007 2008 2009 2010 2011 2012Domestic Demand 3.6 0.6 -1.4 0.6 2.4 3.2 Private Consumption 3.0 1.8 -1.6 -0.4 1.5 2.9 Fixed Investment 7.1 -3.2 -3.4 0.7 3.8 5.4 Stockbuilding (% of GDP) 0.5 0.0 -0.2 -0.1 0.2 0.2 Government Consumption 1.8 2.2 1.8 2.3 2.5 2.5Exports of Goods and Services -4.5 1.9 1.7 3.9 6.4 6.3Imports of Goods and Services -1.9 1.1 0.3 2.9 5.4 6.3GDP 3.0 0.8 -1.0 0.9 2.6 3.1Industrial Production 0.4 -1.5 -2.7 0.4 2.2 1.5CPI 2.3 3.8 2.3 1.2 1.8 2.0Current Balance (% of GDP) -3.8 -2.5 -2.4 -2.2 -1.9 -2.0Government Budget (% of GDP) -2.7 -4.5 -6.8 -7.4 -6.3 -5.0Short-Term Interest Rates (%) 5.95 5.53 2.63 2.34 3.28 4.28Long-Term Interest Rates (%) 5.01 4.66 4.39 4.73 5.03 5.17Exchange Rate (US$ per £) 2.00 1.87 1.53 1.62 1.72 1.73Exchange Rate (Euro per £) 1.46 1.27 1.22 1.31 1.39 1.40

Forecast for UK(Annual percentage changes unless specified)

Sectors and Regions

32

Services an ever growing part of the economy

0

10

20

30

40

50

60

70

80

90

1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010

% GDP

Source: Oxford Economics

Services

ConstructionManufacturing

Forecast

33

…and an ever rising part of employment

0

10

20

30

40

50

60

70

80

90

1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010

% Employment

Source: Oxford Economics

Services

Construction

Manufacturing

Forecast

34

Finance & business growing within services

0

5

10

15

20

25

30

35

40

45

1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010

% Services

Source: Oxford Economics

Other

Business

Distribution

Forecast

CommunicationTransport Finance

GVA

35

…though business not finance for jobs

0

5

10

15

20

25

30

35

40

45

1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010

% Services

Source: Oxford Economics

Other

Distribution

Business

Forecast

CommunicationTransportFinance

employment

36

Finance & business worst hit by recession

(total employment change, 000s) 1978-08 1998-08 2008-10 2008-18Manufacturing -3977 -1382 -193 -674Other production -282 272 -142 74Financial & business services 3735 1508 -300 818Other private services 2888 1138 -197 416Public services 2425 1449 95 527Total 4789 2985 -737 1161

(average per year, 000s) 1978-08 1998-08 2008-10 2008-18Manufacturing -133 -138 -96 -67Other production -9 27 -71 7Financial & business services 124 151 -150 82Other private services 96 114 -99 42Public services 81 145 48 53Total 160 299 -368 116

UK employment change by broad sector (000’s)

Source: ONS; Oxford Economics forecasts

37

How are regional economies affected?

Type of impact Where would we expect biggest effect?

Financial services industry

Where greatest number of jobs are located

Construction Where housing starts and office building have been strongest

Housing Where price disequilibria have been greatest

Consumer Where there are highest real income effects, consumer debts, unemployment impacts

Population Where inward migration has been most driven by availability of jobs

Second-round effects

Where consumer-related industries and services are located; areas that supply most-affected regions

38

More like 1990s than 1980s

Impacts on total employment of each ‘recession’ (000’s)

1981-1983 1991-1993 2001-2003 2008-2010

South East -12 -89 3 -76London -142 -210 -20 -211Eastern 1 -55 68 -78South West -68 -76 43 -34West Midlands -75 -114 18 -66East Midlands -21 -76 16 -43Yorkshire & Humber -80 -53 86 -47North West -164 -94 94 -91North East -66 -21 40 -17Wales -58 -18 44 -20Scotland -82 -50 12 -36Northern Ireland -11 -6 23 -17UK -778 -864 429 -737

39

The forecast: Southern regions hit hardest by contraction in jobs

92

97

102

107

112

117

122

1990 1994 1998 2002 2006 2010 2014

Index (1990=100)

Source : Oxford Economics

South

NIWSMidlands

North

Total Employment in the regional groups (1990=100)

40

Services vital to North West economy, too…

Note: Other includes agriculture, extraction, utilities, financial services and public admin

Distribution & retail17%

Other personal services

6%Transport & comms

6%

Hotels & catering7%

Construction7%

Education8%

Other9%

Manufacturing12%

Health12%

Business services16%

Share of employment, 2008

41

…and critical to recovery from recession

(total employment change, 000s) 1978-08 1998-08 2008-10 2008-18Manufacturing -654 -174 -24 -88Other production -50 30 -14 6Financial & business services 347 178 -27 65Other private services 215 92 -29 34Public services 245 153 4 35Total 102 279 -91 52

(average per year, 000s) 1978-08 1998-08 2008-10 2008-18Manufacturing -22 -17 -12 -9Other production -2 3 -7 1Financial & business services 12 18 -13 6Other private services 7 9 -15 3Public services 8 15 2 4Total 3 28 -46 5

North West employment change by broad sector (000’s)

42

Conclusions

Recession seems inevitable for UK and other developed economies.

Severity will be affected by scale of consumer retrenchment.

But policy now heavily geared to supporting growth, and possible to see upsides as well as downsides to the forecast.

Services – and London – most heavily affected by slowdown, but services are also the key to recovery.

North West still expected to see appreciable jobs (and population) growth in the medium term.