UK economy: Growth will pick up in 2013

After very weak growth in the final quarter of 2012, the British economy is picking up in 2013 according to our forecasts. While real pay and BOEs Funding for Lending Scheme are supporting growth in 2013 the fiscal squeeze pulls in the opposite direction. Meanwhile the recession in the Euro zone still is the largest risk for the UK economy although the near-term risk of a break-up may have receded. If UK businesses share that assessment they might feel more confident about hiring and investment decisions. Monetary policy appears likely to remain unchanged over the near term since the minutes from the December meeting suggested that the MPC are unwilling to expand asset purchases now. But inflation pressures are generally low and there is significant spare capacity in the economy. Moreover the new Bank of England Governor may change the game plan; for example in a speech just before Christmas Mr Carney discussed alternatives to inflation-targeting, such as nominal GDP targeting.
Key data Percentage change

WEDNESDAY 9 JANUARY 2013

Mattias Brur
SEB Economic Research

2011 2012 2013 2014 GDP* Unemployment** Inflation* Government deficit**

Source: SEB

0.9 8.1 4.5 -8.5

0.1 8.1 2.7 -8.2

1.3 8.3 1.8 -7.3

1.6 8.5 1.5 -5.8

* Percentage change, ** Per cent of labour force, *** Per cent of GDP

Economic Insights

UK households are in relatively good shape; while confidence in the household sector still is much lower compared to most business surveys, we estimate that real disposable incomes rose at around 2% in 2012 after the 1% decline in the year before. Moreover, the savings rate is at its highest level since 1997 (7.4%) and the BOEs Funding for Lending Scheme is increasing the availability and reducing the cost of credit for households and businesses alike. The manufacturing sector PMI increased sharply to 51.4 in December while the services PMI fell to 48.9, its lowest level since December 2010. But after the strong third quarter during which British growth topped EU charts, the composite PMI is consistent with negative real GDP growth in Q4. According to the housing price indices we follow the year-on-year trends have been broadly flat since 2010. But since inflation has been relatively high, in real terms UK house prices have actually been deflating. Mortgage applications are rising, however, thus suggesting that the increase in credit availability is reflected in actual lending.

Economic Insights

Considering the weak GDP growth last year, the labour market was surprisingly resilient. Job creation has been rapid and unemployment has fallen. The flip side is that productivity growth has been weak, especially in services. Since the Second World War, productivity has climbed steadily at around 2 per cent yearly, but since 2007 there has been a total stagnation. This means that the gap between productivity and its long-term, prerecession trend is a full 12 per cent and last year productivity fell outright. Looking ahead we expect a degree of normalization in productivity growth, leading to an increase in unemployment from 8.1per cent in 2012 to 8.5 per cent in 2014. Labour productivity, measured as output per worker, is declining 1.7 per cent year on year. Aside from the plunge in 2008-09 such poor productivity growth has not been seen since the early 1980s. This is accentuating worries about structural growth problems in the British economy. Our longer-term view is that productivity growth has not been permanently damaged so at some point GDP growth should pick up significantly.

Economic Insights

Industrial production and exports are weak indeed. Both real estate transactions and residential investment are around half their pre-recession level. But the Funding for Lending Scheme is leading to easier lending conditions and housing activity should contribute positively to growth in 2013. Real GDP is 14 per cent below the level it would have reached had the severe recession in 2008-2009 not occurred and the economy continued to grow at its long-run rate. Nevertheless, according to OECD the output gap is only 4.2 per cent of GDP and according to the OBR it is less than 3 per cent. In our view the output gap is at least as big as the OECD estimate suggests. In other words, the UK economy has a potential to grow above trend for several years without inflation taking off. Nominal GDP is some 18 per cent below its pre-recession trend which merits attention since incoming Governor Mark Carney has discussed nominal GDP targeting as an alternative to inflation targeting. A less radical change that Carney also has suggested is Fed-style thresholds for inflation and unemployment that must be met before any policy tightening may occur. The fiscal consolidation was a severe headwind for the economy last year and the drag will be almost as big this year too.