1

UK ECONOMY

SITUATION & PROSPECTS Peter Matheson

Economic Counsellor

British Embassy, Washington D.C.

January 2012

The UK recovery faces significant headwinds

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The UK has experienced sluggish growth over the past year.

Externally generated shocks have largely been to blame. Commodity prices in particular

have pushed up inflation, squeezed household income and held back consumption.

The UK grew by less than 1 per cent in 2011 but the OBR expect little extra growth

until mid-2012.

The biggest risk facing the UK economy is a crisis in the eurozone. Assuming this

does not happen, the OBR gives a 1 in 3 chance of a technical recession (2 quarters of

Source: ONS and OBR forecast

Quarterly GDP Growth

-2.5

-2

-1.5

-1

-0.5

0

0.5

1

1.5

2006 2007 2008 2009 2010 2011 2012 2013 2014

Percentage change on previous quarter

OBR forecast2011 Q3

Growth is predicted to pickup after 2012

3

The OBR expect the economy to gain momentum through next year.

Growth is expected to rise above its trend rate (2.3%) by 2014.

Source: OBR, Nov 2011

Annual GDP Growth Forecast

2011 2012 2013 2014 2015 2016

Annual GDP growth % 0.9 0.7 2.1 2.7 3.0 3.0

Trade and investment will drive the recovery

4

The OBR expect the recovery to be driven by investment (red bars) and net

trade (blue bars).

HMG’s prosperity goals to boost trade and investment are therefore key.

Source: OBR, Nov 2011

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

2011 2012 2013 2014 2015 2016

Other Net Trade Investment GDP

Contributions to annual GDP growth (percent)

OBR Forecast

Contributions to GDP Growth

By 2014 UK growth will be 2nd highest in the G7

5

Source: IMF World Economic Outlook, September 2011

0

0.5

1

1.5

2

2.5

3

3.5

Italy Japan France UK Germany US Canada

2011-13 2014-16 Average annual GDP growth (percent)

The IMF expects the UK to grow by 1.7% on average between 2011 and 2013 – in the

middle of the pack of the G7 economies.

From 2014 the UK is expected to be the second fastest growing economy in the G7,

growing by 2.7% per year between 2014 and 2016.

Average annual GDP Growth forecasts

Unemployment is lower in the UK than most

advanced economies

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The UK’s unemployment rate is lower than many advanced economies and is

expected to stay so based on the IMF’s forecasts.

The current UK unemployment rate is 8.3%, compared with 8.6% in the US and

10.3% in the eurozone.

Source: IMF World Economic Outlook Database, September 2011

0

2

4

6

8

10

12

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Eurozone

France

UK

US

Germany

Japan

Unemployment Rate (per cent)

IMF ForecastsHistorical Data

A competitive pound offers opportunities for UK

exporters

Sterling has depreciated by more than 20% since 2007 against a broad basket of

currencies (left hand chart), including against the dollar and euro (right hand chart).

A weaker pound makes UK exports cheaper abroad, making UK businesses more

competitive.

Source: Bank of England

7

70

75

80

85

90

95

100

105

2007 2008 2009 2010 2011

Sterling effective exchange rate index, 2007 = 100

1

1.2

1.4

1.6

1.8

2

2.2

2007 2008 2009 2010 2011

Exchange rate to the pound

dollars per pound

euros per pound

Source: Bank of England

Sterling exchange rate index Dollar & euro exchange rates to pound

Geographical split of UK exports

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Good and Services Exports in 2010 Source: ONS Pink Book 2011

Export Market Share of UK Exports (%)

2010 value in £ billion

1 USA 16.5 72.21 2 Germany 8.9 38.71 3 Netherlands 7.2 31.32 4 France 6.4 28.14 5 Ireland 5.8 25.32 6 Belgium 3.7 16.27 7 Spain 3.5 15.08 8 Switzerland 3.2 14.20 9 Italy 3.2 14.00

10 China 2.3 10.26 11 Japan 2.0 8.65 12 Sweden 1.9 8.47 13 Australia 1.9 8.39 14 Singapore 1.6 7.11 15 Canada 1.6 7.03 16 India 1.4 6.13 17 Hong Kong 1.4 6.06 18 Denmark 1.3 5.67 19 Norway 1.3 5.50 20 Saudi Arabia 1.2 5.41

Eurozone42.2%

Rest of EU5.9%

EFTA4.6%

Rest of Europe

3.4%

United States16.5%

Rest of Americas

4.5%

China2.3%

Japan2.0%

Other Asia12.3%

Australasia2.2%

Africa3.9%

The UK exports all over the world.

65% of UK exports are sold in the European Union and United States.

Looking ahead, the rapidly expanding emerging markets of Asia, Africa and Latin America

are likely to offer the greatest potential for future growth.

Distribution of UK Exports

Top 20 largest export markets for the UK

UK exports are diverse, with a mix of

goods and services

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The UK is a top ten global manufacturer, and

goods comprise over 60% of our exports.

Within services exports, financial services are a

huge strength. But three quarters of UK service

exports come from non-financial services..

Source: ONS

Other

business services

30%

Financial services

25%

Travel

services12%

Transport services

12%

Other services

21%

Semi-Manufact

ured Goods11%

Chemicals

19%

Oil and other

Energy13%

Motor Cars7%

Other consumer

goods8%

Finished manufact

ured goods32%

Food, beverages & tobacco

6%

Other

Goods4%

Goods Exports, 2010

Services Exports, 2010 0

50

100

150

200

250

300

350

400

450

500

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Services Exports

Goods Exports

Total Exports

£ billion value of UK exports (current prices)

UK export split between goods and services

Growth Strategy: The UK aims to create the

most competitive tax system in the G20

The most competitive tax system will include:

The lowest corporate tax rate in the G7 and among the lowest in the G20.

The rate is currently 26 per cent and by 2014 it will reach 23 per cent

Making the UK the best location for corporate headquarters in Europe.

Working towards a simpler, more certain tax system. 10

“The most competitive tax system in the G20 is the first of our economic ambitions.” “Our corporate tax rate (will come) right down to 23%; 16% lower than America, 11% lower than France and 7% lower than Germany – the lowest corporation tax in the G7.”

Chancellor George Osborne

The UK faces an exceptional fiscal challenge…

Source: IMF World Economic Outlook, September 2011

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According to the IMF, the UK is running one of the largest fiscal deficits in the advanced

world, which is not sustainable. In 2011, the IMF estimates the UK had the third largest

fiscal deficit as a percentage of GDP in the G7.

The fiscal deficit is the difference between public spending and Government revenue

from taxation. Government borrowing is required to fund the deficit. This in turn increases

Advanced economies fiscal balances in 2011

-15

-10

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Fiscal balance as a share of GDP in 2011 (defined as Public Spending minus Public Revenue)

Surplus

Deficit

Extra austerity measures announced in the Autumn

Statement have put public finances back on track

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-5

-4

-3

-2

-1

0

1

2

2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17

March 2011 Forecast

November 2011 Forecast excluding new austerity measures

November 2011 Forecast with new austerity measures

Cyclically adjusted current balance (per cent of GDP)

60

62

64

66

68

70

72

74

76

78

80

2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17

March 2011 Forecast

November 2011 Forecast excluding new austerity measures

November 2011 Forecast with new austerity measures

Public sector net debt (per cent of GDP)

The sharp deterioration in public finances between March and November is clear by the

shift from the blue line to the red dotted line in charts above. Without additional austerity

measures, the government would have missed its debt and deficit targets.

Consequently, the government announced additional savings of £8bn in 2015/16 and

£15bn in 2016/17 in the Autumn Statement.

Government Deficit Target Government Debt Target

Source : OBR, Autumn 2011 Statement

The OBR predicts that the Government will

achieve its fiscal mandate

In each Budget Report and statement on the economy, the OBR confirms whether or

not Government policy is consistent with a better than 50% chance of achieving the

fiscal mandate.

After announcing additional austerity measures in the Autumn statement, the OBR’s

November 2011 report concludes that current policy is consistent with this aim.

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Source: OBR, November 2011

Per cent of GDP

Outturn Forecast

2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17

Cyclically-adjusted surplus on

current budget

-5.5 -4.5 -4.6 -3.9 -2.7 -1.6 -0.6 0.5

Public sector net debt

52.9 60.5 67.5 73.3 76.6 78.0 77.7 75.8

CONCLUSIONS

> 2012 will be a tough year for the UK economy;

> Growth expected to pick-up;

> The balance of growth will move more towards exports and investment;

> Our fiscal strategy is expected to pay dividends

> Our growth strategy will complement this.

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The UK’s credible fiscal framework has kept

the cost of issuing public debt down

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0

1

2

3

4

5

6

7

8

Jan-2010 Apr-2010 Jul-2010 Oct-2010 Jan-2011 Apr-2011 Jul-2011 Oct-2011

Yield on 10-year government bonds

Italy

France

Germany

UK

US

Cost of issuing government debt – 10-year yields

Source : DataStream

Although the UK faces considerable fiscal challenges, the government’s commitment to

hitting its fiscal targets has kept the cost of issuing government debt low.

By contrast, yields on government debt in other countries, notably in the eurozone, have

risen substantially. This reflect investor fears of a eurozone crisis and its impact on the

sustainability of public finances in those countries.

Summary of Economic Indicators Forecast by Office for Budget Responsibility (OBR), Nov 11

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OBR forecasts (percentage change year on year, unless given)

2011 2012 2013 2014 2015

Real GDP growth 0.9* 0.7 2.1 2.7 3.0

CPI Inflation 4.5 2.7 2.1 2.0 2.0

ILO unemployment rate (%) 8.1 8.7 8.6 8.0 7.2

Current Account (%GDP) -2.3 -2.6 -1.8 -1.6 -1.4

2011-12 2012-13 2013-14 2014-15 2015-16

Public net borrowing (%GDP) 8.4 7.6 6.0 4.5 2.9

The next OBR forecasts will be released with the 2012 Spring Budget.