UK Economic Outlook July 2015 - UK housing market outlook: the continuing rise of Generation Rent
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July 2015
UK Economic
Outlook
UK housing market outlook:
the continuing rise of Generation Rent
Does trade hold the key to the UK services
productivity puzzle?
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www.pwc.co.uk/economics
Contents Section 1. Summary 4 2. UK economic prospects 7 • 2.1 Recent developments and the present situation 8 • 2.2 Economic growth prospects: national, sectoral and regional 11 • 2.3 Outlook for inflation and real earnings growth 14 • 2.4 Monetary and fiscal policy 15 • 2.5 Summary and conclusions 16 3. UK housing market outlook: the continuing rise of Generation Rent 17 • Introduction and summary 17 • 3.1 Recent housing market developments 17 • 3.2 Housing tenure in 2025: the continuing rise of Generation Rent? 18 • 3.3 House price prospects: UK and regional projections 23 • Technical Annex – modelling methodologies 26 4. Does trade hold the key to the UK services productivity puzzle? 28 • Introduction and summary 28 • 4.1 The productivity puzzle 28 • 4.2 UK trade performance in services 31 • 4.3 Productivity outlook and policy implications 32 • 4.4 Conclusion 34 Appendices A Outlook for the global economy 36 B UK economic trends: 1979-2014 37 Contacts and services 38 2 UK Economic Outlook July 2015
Highlights and key messages
for business and public policy
• The UK economy slowed a little in
Key projections
early 2015 but domestic demand
growth remained relatively strong, 2015 2016
helped by lower oil prices. Net exports
Real GDP growth 2.6% 2.4%
continued to subtract from UK growth,
reflecting sluggish growth in early Inflation (CPI) 0.3% 1.7%
2015 in both the US and the Eurozone.
Source: PwC main scenario projections
• In our main scenario we expect UK
GDP growth to average around 2.6% will be offset for some lower earners government has set as an objective,
in 2015, which could again be the by the new National Living Wage. will require a range of measures
fastest in the G7, before easing including further planning reform,
slightly to around 2.4% in 2016. House price growth moderates but rise action to address skills shortages
Consumer spending and business of Generation Rent will continue in the housebuilding sector and
investment will be the main drivers of enhanced financial incentives to build
• UK house price growth has
UK growth in these years. more homes. But cuts to social rents
moderated recently, particularly in
announced in the Budget will tend to
London. But lack of supply means that
• Risks to growth are weighted work against this for local authorities
we expect medium-term UK house
somewhat to the downside in the and housing associations, while
price growth to average just over 5%
short term due to international risks, private developers may be cautious
per annum over the period to 2020.
including uncertainties relating to about expanding too rapidly. So we
Greece and the recent turbulence expect housing supply shortages to
• This would be somewhat higher than
in the Chinese stock market. But persist for at least the next decade.
expected average earnings growth of
there are also upside possibilities
around 3-4%, implying some further
in the medium term if the global Services sector remains key driver of
worsening of affordability problems
environment improves and real growth and trade
in getting on to the housing ladder,
wage and productivity growth
particularly as mortgage rates are • The services sector will remain the
rates accelerate in the UK.
also likely to increase gradually over main engine of UK growth for both
the rest of this decade. output and employment, with
• London and the South East continue to
manufacturing and construction
lead the recovery, with growth of
• As a result, we expect a continuing growth having slowed since last
around 3% in 2015, but all other UK
rise in the proportion of households summer.
regions should also register positive real
renting from around 20% now to
growth of around 1.8-2.5% in 2015.
around 25% by 2025. For 20-39 year • Productivity growth has been
olds, we would expect over half to be relatively weak since the crisis in
• Inflation seems likely to rise back
renting by 2025, implying a financial services and also remains
towards its 2% target by the end of
continuing rise in the size of subdued in the public sector. But it
2016, so the MPC may start to raise
‘Generation Rent’. remains stronger in other non-
interest rates gradually from early next
financial private services sectors,
year. Businesses and households should
• At the other end of the housing where we estimate the long-term
plan for rates to be back to around
market, we would also expect a trend productivity growth rate at
3-3.5% by 2020.
growing number of older households around 1.7% per annum.
to own their home outright, while
• The July Budget confirmed plans for
fewer would have mortgages. In total, • Services have also become
significant further fiscal tightening to
we project the owner occupation rate increasingly important for UK trade.
eliminate the budget deficit before
to fall to around 60% by 2025, down Indeed we expect the total value of
the end of this decade, but with a
from its peak of just under 70% in the UK services exports to exceed that of
somewhat slower and smoother
mid-2000s. manufactured goods exports by 2020.
profile of public spending cuts and
around £7 billion per annum of net
• Increasing the supply of affordable
tax rises to be phased in by 2020. The
housing in the long run, which the
impact of £12 billion of welfare cuts
UK Economic Outlook July 2015 31 – Summary
Recent developments Table 1.1: Summary of UK economic prospects
The UK economy grew by 3% in 2014 as Indicator OBR forecasts Independent PwC Main
a whole, which was the fastest rate seen (% change on (July 2015) forecasts scenario
since 2006 and the strongest growth previous year) (June 2015) (July 2015)
rate in the G7. 2015 2016 2015 2016 2015 2016
However, UK growth slowed somewhat GDP 2.4 2.3 2.5 2.3 2.6 2.4
to 0.4% in the first quarter of 2015, Consumer spending 3.0 2.5 2.7 2.4 2.8 2.5
which appears to reflect the drag in that
period from sluggish growth in the US Source: Office for Budget Responsibility (July 2015), HM Treasury survey of independent forecasts (average values in June 2015
survey) and latest PwC main scenario.
and the Eurozone and the ongoing
problems in Greece, as well as pre-
election political uncertainties at home The rate of consumer price inflation We expect net exports to continue to
and wider global geopolitical risks (CPI) has fallen sharply over the past make a negative contribution to UK GDP
related to the situation in Russia/ year as import price inflation has growth in 2015 given ongoing sluggish
Ukraine and the Middle East. dropped due to global energy and food growth in the Eurozone and only
price declines. But we expect this effect moderate rates of US growth, though
In contrast, UK domestic demand to be only temporary. both may pick up somewhat in 2016.
growth remained strong in the first
quarter, driven by rising employment, Future prospects As always there are many uncertainties
a pick-up in earnings growth and the As shown in Table 1.1, our main scenario surrounding our growth projections, as
benefits of lower global oil prices for is for UK GDP growth to average around illustrated by the alternative scenarios in
UK consumers and most businesses. 2.6% in 2015 and around 2.4% in 2016. Figure 1.1. There are still considerable
This is broadly similar to the latest downside risks relating to developments in
UK growth continues to be driven primarily consensus and OBR forecasts. Greece and the Eurozone more generally,
by services, with manufacturing and and in some emerging markets (including
construction growth having slowed in late Consumer spending growth is projected China as noted above). But there are also
2014 and early 2015. to be slightly stronger than GDP growth, upside possibilities if these problems can be
with a boost from lower oil prices and contained and a virtuous circle of rising
Business investment has shown signs increased real earnings growth, but confidence and spending can be
of a stronger recovery in the latest follows a similar path over time. established as in past economic recoveries.
official data, although this has not yet
translated into stronger productivity We expect continued relatively strong Inflation will remain very low this year,
growth. Public spending cuts have business investment growth in 2015 and but could rebound to close to its 2%
slowed down somewhat over the past 2016, but at a somewhat slower rate target by the end of 2016 assuming
couple of years, but the Budget than in 2014. Business confidence could there is no repeat of past falls in global
confirmed they will continue at a steady be affected by increased international energy and food prices. There could be
pace for the next four years. The Budget risks relating to Greece, recent upside risks to this inflation outlook in
also announced net tax rises building up turbulence in the Chinese stock market the longer term if domestic wages
to around £7 billion by 2020. The impact (which could have wider contagion continue to recover without a
of severe welfare cuts will be offset for effects within China and beyond) and corresponding rise in productivity.
some lower earners by the new more continued unrest in parts of the Middle
generous National Living Wage, which is East and North Africa, as well as We do not expect any immediate rise in
estimated to rise to over £9 per hour by uncertainties around the planned official UK interest rates, but a gradual
2020 for those aged 25 and over. referendum on UK membership of the upward trend seems likely from early
EU. But the domestic outlook still seems 2016 onwards. In the long term, we
reasonably favourable for UK business would expect official rates to rise very
investment, helped by the corporation gradually to more normal levels of
tax rate cut announced in the Budget. around 3-3.5% by 2020.
4 UK Economic Outlook July 2015Higher interest rates will help savers Figure 1.1 – Alternative UK GDP growth scenarios
and reduce pension fund deficits, but
borrowers (including businesses and the
6
government) might gain from locking in Projections
funding now for long term investments 4
such as infrastructure and housing. % change on a year earlier 2
Households need to bear in mind likely
0
future interest rate rises in any decisions
on mortgages or other longer term loans. -2
-4
Housing market outlook: the
-6
continuing rise of Generation Rent
-8
As discussed in detail in Section 3 of this 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1
report, UK house price growth has
decelerated over the past year, Main scenario Renewed slowdown Strong recovery
especially in London. Nonetheless, we
project that average UK house prices Source: ONS, PwC scenarios
could still rise by around 5% this year.
Assuming that the supply of new homes Figure 1.2. Projections for UK housing tenure, share of households
continues to be relatively sluggish,
house prices are expected to keep 45
growing at around this 5% annual rate Mortgaged Projections
40
for the rest of this decade. In our
Proportion of households (%)
35
baseline scenario, the average UK house 30
Owned outright
could be worth around £360,000 in cash 25
terms by 2020. There could be some 20
Social rental
convergence between lower house price 15
regions like Northern Ireland and the
10
national average, but only at a slow rate Private rental
5
over the rest of this decade.
0
1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 2025
As house prices have risen and social
housing supply remains constrained, Owned outright Mortgaged Private rental Social rental
the number of households in the private
rented sector has more than doubled
Source: PwC analysis, English Housing Survey
since 2001, rising from 2.3 million to
5.4 million by 2014, around 20% of the
total. We project that this trend will million in 2001 to only around 8 million in of the total, by 2025. A key driver is the
continue with an additional 1.8 million 2014. We project a further decline to 7.2 rising proportion of over 60 year olds in
households becoming private renters by million by 2025 as limited housing supply, the UK, who are far more likely to have
2025. This would take the total to 7.2 affordability and mortgage availability paid off their mortgages.
million households – around one in four make it harder for first time buyers to get
of the UK total (see Figure 1.2). The on the housing ladder. In total, we project the owner
trend is particularly strong in the 20-39 occupation rate to fall to around 60% by
age group where we expect more than The other key tenure trend is that a 2025, down from its peak of just under
half to be renting privately by 2025. greater number of people than ever before 70% in the mid-2000s.
own their own home outright. This now
Fewer households will have mortgages. accounts for 8.4 million households or
The number of households who own their 32% of the total. We expect this to rise to
home with a mortgage fell from around 10 10.6 million households, around 35%
UK Economic Outlook July 2015 5Increasing the supply of affordable Figure 1.3: Core UK private services productivity trend has been around 1.7% since 1995
housing in the long run, which the
government has set as an objective, 145
Output per job in UK services, 1995=100
will require a range of measures 140
including further planning reform, 135
action to address skills shortages in 130
the housebuilding sector and enhanced 125
financial incentives to build more 120
homes. But cuts to social rents 115
announced in the Budget will tend to 110
work against this for local authorities 105
100
and housing associations, while private
95
developers may be cautious about 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
expanding too rapidly. So we expect Core private services Total public and private services 1.7% Trend
housing supply shortages to persist for
at least the next decade.
Source: ONS
The UK services productivity puzzle
and trade performance
pre-crisis productivity trend. In other comparative advantage in many
The UK has a highly services-oriented words, productivity growth before the tradeable services sector activities and
economy. Services make up nearly 80% of crisis was inflated by this one-off shift. this has contributed to a substantial
GDP and more than 80% of employment. trade surplus in services, which is now
So understanding the services sector is Second, the financial and property sectors around 5% of GDP – offsetting the UK’s
critical to analysing the performance of have been a serious drag on productivity deficit in manufactured trade. Future
the British economy as a whole and this is since the crisis, as banks have restructured trade agreements which open up
discussed in detail in Section 4 of this and had to deal with increased regulation. overseas markets to UK services firms
report in an article by Andrew Sentance, In retrospect, the strong pre-crisis could be highly beneficial for the future
our senior economic adviser. productivity growth of the banking sector growth of the UK economy.
Recent economic debate has focussed looks to have been unsustainable.
on the so-called “productivity puzzle”. Extrapolating from recent trends, we
Output per person employed (or per Third, public sector productivity has project that the total value of UK
hour) has not grown as strongly since also been disappointing both before and services exports will exceed that of
the financial crisis as before. The bulk particularly after the crisis – at least manufactured goods exports by 2020,
of this puzzle reflects the performance according to the official GDP estimates the first time this has happened.
of the services sector. In the decade (though there are serious measurement
from 1995 to 2005, services sector difficulties in this area).
productivity grew by 2% per annum on
average. Since 2005, it has increased by Once we allow for these three factors,
an average of just 0.6% per year - less the core productivity rate in UK private
than a third of the previous rate. non-financial services has been on a
more consistent trend since the mid-
Our analysis suggests that three main 1990s, which we estimate at around
factors have contributed to this 1.7% per annum (see Figure 1.3).
productivity growth slowdown. First,
a number of highly tradeable services Our analysis in Section 4 also highlights
activities provided a boost to the potential role of trade in boosting
productivity before the financial crisis. productivity within UK services. In
These sectors benefited from the general, services activities are less open
globalisation of the world economy, to trade than the production of goods.
providing a temporary increase in the But the UK appears to have a strong
6 UK Economic Outlook July 20152 – UK Economic prospects
Key points • Headline inflation has been close
Introduction
to zero recently, but this is mostly
• T
he GDP growth rate in the UK In this section of the report we describe
a temporary effect of past global
was 3% in 2014, the highest in the recent developments in the UK economy
energy and food price falls. As these
G7. Growth slowed in early 2015, and review future prospects. The
fall out of the 12-month inflation rate
but there are signs of a revival discussion covers:
towards the end of 2015, we would
more recently.
expect inflation to rise back towards
its 2% target rate by the end of 2016. 2.1 Recent developments and the
• W
e expect the UK economy to grow present situation
Higher unit labour cost growth as
by around 2.6% in 2015 as a whole,
wages rise will also contribute to
somewhat above trend and possibly 2.2 Economic growth prospects:
higher inflation in the medium term.
again the fastest in the G7, before national, sectoral and regional
moderating slightly to around 2.4%
• The Bank of England is likely to
in 2016 in our main scenario. 2.3 Outlook for inflation and real
respond to this by raising interest
rates gradually from early 2016 earnings growth
• T
he services sector remains the
onwards, though a case could be
key driver of UK growth, which 2.4 Monetary and fiscal policy options
made for moving earlier than that. In
continues to be powered by domestic
any event, businesses and households
private demand. The construction 2.5 Summary and conclusions
should prepare for higher borrowing
sector has cooled from the rapid
costs in the medium term, perhaps
growth rates seen in mid-2014, though
reaching around 3-3.5% by 2020.
there were signs in June of a post-
election upturn. The manufacturing
• The July Budget set out plans for
sector continues to be held back by
further fiscal tightening over the next
relatively weak growth in the
four years through a combination of
Eurozone and the comparative
public service spending cuts, welfare
strength of the pound against the euro.
benefit cuts and net tax rises, which
should eliminate the budget deficit
• L
ondon and the South East have
before the end of the decade. This
been the fastest growing regions in
will be a drag on growth over this
the UK since the recession and are
period, though there should be
expected to maintain this position
offsetting benefits from lower
with average growth of close to 3%
long-term interest rates than would
in 2015 and 2016. However, most
otherwise be the case.
regions in the UK are expected to
grow by more than 2% per annum in
2015-16, except for Northern
Ireland where average growth may
be slightly below 2%.
• T
he UK recovery is still exposed
to downside risks, including
uncertainties relating to Greece and
possible financial contagion effects
from recent turbulence in Chinese
stock markets. However, there are
also upside possibilities from
stronger than expected trends in real
wage and productivity growth and,
with the election out of the way, UK
business investment.
UK Economic Outlook July 2015 72.1 – Recent developments Figure 2.1 – GDP and key components of domestic demand
and the present situation
115
Quarterly real GDP growth has been
110
running at an average rate of around Government
105
0.8% per quarter during 2014, but the
Index (Q1 2007 = 100)
GDP
latest ONS estimates show that this 100
Household
slowed markedly to around 0.4% in 95
Investment
Q1 2015. Nonetheless, the economy 90
continued to expand and aggregate 85
output is now estimated to be more than
80
10% above its trough in Q2 2009 and
75
around 4.5% higher than at the start of 2007 2008 2009 2010 2011 2012 2013 2014 2015
the recession in Q1 2008 (though real Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1
GDP per capita remains 0.6% below its General government consumption Household spending
pre-recession level after allowing for GDP Fixed investment
population growth).
Source: ONS
The slowdown in GDP growth in the first
quarter reflected a small fall in Construction falls back, services in the construction purchasing managers’
construction output and significantly growth slows but continues to index (PMI) in June.
slower growth in the services and drive economy
manufacturing sectors as compared to As Figure 2.2 shows, the construction The services sector continues to be the
average quarterly rates seen during 2014. sector had been growing very strongly up dominant driver of the UK economy, but
to Q3 2014, but has levelled off since then, growth slowed markedly to 0.4% in the
Economic growth is often erratic from with a small decline estimated in Q1 2015 first quarter due in particular to weakness
quarter to quarter, however, and recent (though this is much less marked now in financial services output, linked in part
data could well be revised significantly than in earlier preliminary estimates). to a slowdown in the mortgage market in
in future, so we generally prefer to focus However, there are signs that growth in late 2014 and early 2015.
on broad trends in the level of economic the sector may have resumed after the
indicators over longer periods of time, general election in May produced a As Figure 2.3 shows, however, the
rather than short term fluctuations in decisive result, as indicated by a rebound Services PMI remained above 55 for the
growth rates.
As Figure 2.1 shows, GDP growth and Figure 2.2 – Sectoral output and GDP trends
consumer spending growth have been
115
on a fairly steady upward trajectory Services
since mid-2009. Fixed investment 110
GDP
growth has been more volatile but has 105
Index (Q1 2007 = 100)
also generally been on an upward 100
Construction
trajectory since mid-2009, with the 95
latest vintages of data showing more Manufacturing
90
positive trends here than earlier
85
estimates. Government consumption
spending remained strong through the 80
recession, but has grown more slowly 75
2007 Q1 2008 Q1 2009 Q1 2010 Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1 2015 Q1
since then (though it has not actually
declined in real terms according to these
Services Manufacturing
official estimates). GDP Construction
Source: ONS
8 UK Economic Outlook July 2015first five months of this year, with the Figure 2.3 – Purchasing Managers’ Indices of business activity
latest June data showing a pick-up to
58.5, perhaps again in part due to a
65
reduction in political uncertainty
Services
following the election. This suggests 60
some pick-up in services output growth 55
between the first and second quarters,
50
which should also feed through into Above 50 Manufacturing
indicates
stronger overall GDP growth. 45 rising activity
levels
40
The manufacturing sector also
35
disappointed with estimated growth
30
of just 0.1% in Q1 2015, and the 2007 2008 2009 2010 2011 2012 2013 2014 2015
manufacturing PMI has also remained Jan Jan Jan Jan Jan Jan Jan Jan Jan
relatively subdued in the second quarter, Services Manufacturing
with the latest data showing a decline to
51.4 in June, which was a 26-month low
Source: Markit/CIPS
(see Figure 2.3). It seems the boost to this
sector from lower oil prices has not yet
come through with any strength, while Figure 2.4 – Productivity and employment
continuing relatively sluggish growth in
the Eurozone, uncertainty about Greece 106
and the relatively strong pound against Jobs
104
the euro, has held back manufacturing
Index (Q1 2007 = 100)
output growth recently. Nonetheless, the 102
data suggest modest but positive growth
100
during the first half of 2015, rather than
Productivity
an outright decline in output in the sector. 98
Employment has risen strongly 96
since 2012, holding down 94
productivity growth 2007 Q1 2008 Q1 2009 Q1 2010 Q1 2011 Q1 2012 Q1 2013 Q1 2014 Q1
Figure 2.4 shows how the number of
Output per job Workforce jobs
workforce jobs and productivity
(defined here as output per job) have
changed since 2007. The workforce has Source: ONS
expanded rapidly for the past three
years, while productivity has been much more detail by Andrew Sentance, Consumers more confident now than
broadly flat according to the official data our senior economic adviser, in Section at any point since 2008
since early 2012, having earlier shown a 4 below, but the general message is that
more normal cyclical recovery between Figure 2.5 shows results from PwC’s
weakness since the recession ended in regular consumer survey alongside
mid-2009 and late 2011. mid-2009 has been concentrated in a trends in retail sales volumes since 2008.
few sectors such as public services, Consumer confidence has been volatile
These two trends are connected and financial services and North Sea oil and
reflect a range of complex factors that over this period, but has shown a clear
gas. Productivity trends in positive trend over the past two years,
vary significantly by industry sector, manufacturing and the non-financial
including measurement issues for which also matches the upward trend in
private services sector have generally retail sales volumes over this period.
services sector productivity in been stronger and should remain so
particular. The general topic of going forward.
productivity growth is discussed in Growth in retail sales values has,
however, been much less strong over the
UK Economic Outlook July 2015 9past 12-18 months, reflecting a trend to Figure 2.5 – Consumer confidence and retail sales volumes
deflation on the high street driven both
by falls in global commodity prices and 0.10 115
intense price competition particularly in Retail sales volume
Consumer confidence (net balance)
Retail sales index (Jan 2007 = 100)
0
the supermarket sector where 110
discounters have played an increasing -0.10
role in the market. -0.20 105
Stocks in Europe rally during Q1 2015 -0.30
100
Consumer confidence
before flattening off in second quarter -0.40
95
As Figure 2.6 shows, equity markets in -0.50
developed economies have grown at
-0.60 90
varying paces since the global financial 2007 2008 2009 2010 2011 2012 2013 2014
Jan Jan Jan Jan Jan Jan Jan Jan
crisis. The US market led the way, with a
fairly consistent underlying upward Consumer confidence (LHS) Retail sales volume (RHS)
trend since 2009. The UK market
initially recovered broadly in line with Sources: PwC Consumer survey, ONS
the US until 2011, but has shown a
shallower upward trend since then,
perhaps because of a greater sensitivity Figure 2.6 – Equity market indices
to European economic problems and
wider geopolitical risks for those 160
international companies that dominate US
140
the FTSE index.
Index (January 2007 = 100)
120 UK
The European equity market (Euronext
100 index) took longer to recover, only 100
starting this process on a sustained basis 80
Eurozone
from mid-2012 onwards when the ECB
introduced its Outright Monetary 60
Transactions (OMT) mechanism and
40
vowed to ‘do whatever it takes to 2007 Jan 2008 Jan 2009 Jan 2010 Jan 2011 Jan 2012 Jan 2013 Jan 2014 Jan 2015 Jan
preserve the euro’. There was a
particularly strong surge in the FTSE 100 Euronext 100 Dow Jones Industrial
European index in Q1 2015 when the
ECB announced its new Quantitative
Source: Thomson Reuters Datastream
Easing (QE) asset purchase programme,
though this levelled off in the second
quarter as ongoing uncertainties around Europe and elsewhere. Other Eurozone At the time of writing, there is also
Greece took centre stage. crisis economies like Spain, Ireland and concern about financial contagion
Portugal are also in better shape than effects from the sharp falls in the
At the time of writing, the outcome of they were in 2011-12, as is the European Chinese stock market in recent months.
the Greek crisis remains highly banking sector more generally. As a While we assume these can be contained
uncertain, so we can expect this to be result, while ‘Grexit’ could still lead to by the Chinese authorities in our main
the source of continued volatility in considerable short-term turbulence in scenario, it remains a downside risk to
European financial markets and beyond. markets, we do not think its effect would our international projections that could
However, with QE and OMT, the ECB be nearly as severe as if this had also have knock-on effects on UK
does now have the tools to limit happened three or four years ago1. financial markets.
contagion from a possible Greece exit
from the euro to other markets in
1 For more discussion of the potential impact of Grexit, see our Economics blog:
http://pwc.blogs.com/economics_in_business/2015/07/what-would-grexit-mean-for-the-eurozone-and-uk-economies.html
10 UK Economic Outlook July 20152.2 Economic growth Table 2.1 - PwC main scenario for UK growth and inflation
prospects: national, % real annual growth 2014 2015 2016
sectoral and regional unless stated otherwise
GDP 3.0% 2.6% 2.4%
As Table 2.1 shows, our main scenario
projection is for UK GDP growth of around Consumer spending 2.6% 2.8% 2.5%
2.6% in 2015, moderating slightly to Government consumption 1.6% 1.4% 0.4%
around 2.4% in 2016. With US growth
Fixed investment 8.6% 5.2% 5.7%
disappointing in early 2015, there is now a
good chance that the UK could repeat its Domestic demand 3.5% 2.9% 2.8%
2014 success in being the fastest growing Net exports (% of GDP) -0.6% -0.4% -0.4%
G7 economy in 2015 (see Appendix A for
our latest global projections). CPI inflation (%: annual average) 1.5% 0.3% 1.7%
Source: ONS for 2014, PwC main scenario for 2015-16
Consumer spending is projected to grow
at a relatively strong pace of 2.8% in
2015, supported by stronger real wage Table 2.2: Official and independent forecasts
growth and continued increases in
(% real YoY growth Latest OBR forecasts Average
employment. These factors may ease a unless stated otherwise) estimates (July 2015) independent
little in 2016, however, so we expect forecast
some moderation in consumer spending (June 2015)
growth to around 2.5% next year.
2014 2015 2016 2015 2016
Business investment is expected to grow GDP 3.0% 2.4% 2.3% 2.5% 2.3%
less strongly in 2015 and 2016 than it
Manufacturing output 3.2% N/A N/A 1.7% 1.9%
did in 2014, but still at a reasonably
healthy rate of around 5-6%. The Consumer spending 2.6% 3.0% 2.5% 2.7% 2.4%
decisive election outcome should be a Fixed investment 8.6% 5.6% 5.6% 4.4% 4.9%
positive factor here, though there are
clearly also still ongoing sources of Government consumption 1.6% 0.8% -0.7% 0.9% -0.1%
uncertainty relating to Greece and other Domestic demand 3.5% 2.6% 2.6% 2.5% 2.3%
international risks, as well as Britain’s
own place in Europe, that could have a Exports 0.5% 3.8% 3.8% 4.0% 3.8%
dampening influence. Higher interest Imports 2.4% 5.1% 4.6% 4.1% 3.6%
rates may also be a negative influence in
the medium term, but not to any Current account (£bn) -106 -93 -75 -86 -81
significant extent in our view given that Unemployment claimant count (Q4, m) 0.91 0.78 0.73 0.72 0.69
the absolute level of interest rates will
remain very low by historic standards Source: ONS for 2014, OBR Economic and Fiscal Outlook (July 2015), HM Treasury Forecasts for the UK economy: a comparison
of independent forecasts (June 2015)
for at least the next few years.
Government consumption is expected to remaining relatively strong (at least growth projections are broadly similar
grow only slowly, with a further against the euro), we expect net trade to to those of other forecasters, with
deceleration in 2016, though not an continue to have a negative influence on differences in GDP growth in particular
absolute decline given the way this is overall GDP growth, but to a somewhat being well within the margin of error of
measured in the national accounts. lesser extent than in 2014. any such projections.
With the UK growing faster than its Table 2.2 shows the OBR and average
major trading partners in the Eurozone independent forecasts of GDP and other
and possibly also the US, and sterling key variables for comparison with our
own main scenario. In general, our
UK Economic Outlook July 2015 11Figure 2.7 – Alternative UK GDP growth scenarios UK average this year, but almost all
should see positive growth of more than
6
Projections 2% in 2015, except Northern Ireland
4 which may be slightly lower at 1.8% in
our main scenario.
% change on a year earlier
2
0 At this stage our model projects all
regions to show a slight deceleration in
-2
growth in 2016 in line with national
-4 economic trends, but this is highly
-6
uncertain at this stage.
-8 It is important to note here that regional
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 data are much less timely than national
data. As a result, the margins of error
Main scenario Renewed slowdown Strong recovery
around these regional projections are
even larger than for the national growth
Source: ONS, PwC scenarios
projections, so they can only be taken as
illustrative of broad directional trends.
Alternative growth scenarios leading to cutbacks in investment Small differences in projected growth
and employment, thereby also rates between regions are not of any
We have considered two alternative UK
depressing consumer spending. practical significance.
growth scenarios in addition to our
main scenario, as Figure 2.7 shows:
We do not believe that these alternative
• Our ‘strong recovery’ scenario scenarios are the most likely outcomes,
projects growth accelerating to but they are certainly well within the
around 4% in 2016. This relatively bounds of plausibility. Businesses
optimistic scenario assumes stronger should ensure they have appropriate
growth in the Eurozone and other contingency plans in place to deal with
global economies, which would the possibility of these kinds of events
also boost consumer and business and outcomes.
confidence in the UK. This in
turn would result in businesses Positive growth expected in all key
undertaking greater investment sectors of the economy, but with
activity, an increase in consumer some significant variations across
spending and greater UK exports. sectors and over time
The sector dashboard in Table 2.3
• Our ‘renewed slowdown’ scenario, shows the actual growth rates for 2014,
by contrast, sees UK GDP growth alongside our projected growth rates
slowing down to below 1% in 2016. for 2015 and 2016, for five of the main
This is based on the assumption of sectors within the UK economy. The
adverse shocks such as a chaotic table also includes a summary of the
Greek exit from the Eurozone, a key issues affecting each sector.
further intensification of unrest in
the Middle East and North Africa and Regional prospects
significantly weaker economic London and the South East are expected
growth in key emerging markets to grow at the fastest pace of all UK
including China. These events would regions at around 3% in 2015, as Figure
have negative implications for UK 2.8 shows. Other regions are expected to
businesses, damaging confidence and expand at a slightly slower rate than the
12 UK Economic Outlook July 2015Table 2.3: UK sector dashboard
Growth
Sector and GVA share 2014 2015p 2016p Key issues/trends
Manufacturing (10%) 3.1% 2.0% 3.1% Manufacturing PMI has remained above 50 for the first 6 months of the year
despite official figures showing slow growth.
Low oil prices should help but sluggish Eurozone growth and the Greek crisis
remain negative factors for UK goods exporters.
Construction (6%) 9.5% 2.3% 2.0% The construction sector has slowed since mid-2014 when it was growing very
rapidly. Output growth rates in residential, commercial and civil engineering
activity have all slowed down since then.
However, construction PMI hit its highest level of 2015 in June, perhaps
boosted by the decisive election result in May.
Distribution, hotels & restaurants 4.8% 4.0% 2.6% Retail sales volumes have been growing strongly, but value growth has
(14%) been lower due to fierce price competition on the high street, particularly
for supermarkets.
Real earnings growth have lifted consumer purchasing power recently and
should keep spending strong this year, but with some reversion to trend
expected next year.
Business services and finance (31%) 3.8% 3.1% 3.2% The business services sector continues to lead the expansion of the UK
economy.
However, the financial sector remains exposed to important risks and
regulatory constraints that may limit future growth.
Government and other services (23%) 1.1% 0.9% 1.2% Government services output has expanded slowly and is expected to
continue to do so given continuing public spending constraint.
Total GDP 3.0 % 2.6% 2.4%
Sources: ONS for 2014, PwC for 2015 and 2016 main scenario projections and key issues. These are only five of the most important sectors of the economy, so their GVA shares only add up to
around 84% rather than 100%.
Figure 2.8 – PwC main scenario for output growth by region
3.5
3.1%
3.0 2.9% 2.9% 2.9%
2.6%
2.5% 2.5% 2.5% 2.5% 2.5% 2.5% 2.5%
2.5 2.4% 2.4% 2.4% 2.2% 2.4% 2.4%
% growth by region
2.3%
2.2% 2.2%
2.1%
2.0% 2.0%
2.0 1.8%
1.7%
1.5
1.0
0.5
0.0
London South East East West East Yorkshire & South North Scotland Wales North East N Ireland UK
Midlands Midlands Anglia Humberside West West
2015 2016
Source: PwC analysis
UK Economic Outlook July 2015 132.3 Outlook for inflation Figure 2.9 – Alternative UK inflation (CPI) scenarios
and real earnings growth 5.0
Projections
Inflation falls to around zero, but
4.0
likely to be only a temporary dip % change on a year earlier
Consumer price inflation (as measured 3.0
by CPI) had been fluctuating close to
2.0
deflationary levels in the first quarter Inflation target = 2%
of 2015 and was driven down to -0.1% 1.0
in April. The primary causes of this
0
downward trend included falls in
costs of imported goods (especially -1.0
food and energy) over the past year, 2010 2011 2012 2013 2014 2015 2016
Q1 Q1 Q1 Q1 Q1 Q1 Q1
supermarket price wars and cheaper Main scenario Low inflation High inflation
transport services. The timing of the
Easter break in April exacerbated the Source: ONS, PwC scenarios
effect of decreased transport costs, but
this was reversed in May. Inflation was
This would matter less if higher • In our ‘low inflation’ scenario, by
zero in the year to June.
earnings growth was matched by higher contrast, we assume that UK domestic
productivity growth, but this has not demand growth will be slower, global
The Bank of England has estimated
happened yet as discussed in Section 2.1 GDP growth rates will deteriorate due
that around three-quarters of the 2
above and in more detail in Section 4. to shocks including a chaotic Greek
percentage point shortfall of inflation
exit from the Eurozone and commodity
from its target was attributable to
As with our GDP scenarios, we have prices will remain weak. Here, we
falling prices of energy, food and other
considered two alternative scenarios project that average annual inflation
imported goods. The other quarter of
for UK inflation: rates will remain below 1% in 2016.
the shortfall reflected slow growth in
earnings and weak upward domestic
• In our ‘high inflation’ scenario, As with GDP growth, these alternative
price pressure. It can be expected that
which assumes stronger global scenarios are not as likely as our main
the windfall from the shock of low
growth and a marked rebound in scenario, but businesses should plan for
energy, food and other imported goods
oil prices, we project headline such contingencies.
will dissipate over the next 12 months,
inflation to increase to just under
leading to higher inflation later in 2015
3% on average in 2016.
and through 2016.
Alternative inflation scenarios Figure 2.10 – CPI inflation vs average earnings growth
As Figure 2.9 shows, in our main 5.0
scenario, we expect the annual rate of Projections
CPI
inflation to average 0.3% this year and 4.0
1.7% in 2016, returning close to target by
% change p.a.
the end of next year. Our expectations 3.0
that inflation will increase in 2016 are in Real squeeze
line with those of the OBR and most 2.0
independent forecasters. This higher
inflation rate will result not only from 1.0
Earnings
past international price shocks
dissipating but also domestic wage 0
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
pressures building up as the labour
market tightens, which is already evident CPI Average weekly earnings (excl bonus)
in the earnings data for recent months.
Source: ONS for data up to 2014, PwC analysis for 2015-17
14 UK Economic Outlook July 2015A positive outlook for real a minority vote for an early increase continued expected strong employment
earnings growth seems quite likely to emerge, perhaps growth across the economy as a whole.
from August onwards. Sectors with relatively low pay such as
After the recession hit in 2008, average
hotels and restaurants, social care and
UK real earnings fell consecutively for
Our main scenario assumes, however, parts of retailing could, however, face
6 years. This can be seen in Figure 2.10,
that the Bank rate will only start to some tough choices on how to adapt to
which shows that the inflation rate
rise from early 2016, with increases these higher minimum wage levels.
exceeded nominal earnings growth
between 2008 and 2014. This trend has proceeding at only a very modest pace
after that. In the medium term, On the tax side, there was the usual
now reversed. Inflation levels fell rapidly
however, official rates could increase to complex mix of offsetting measures.
below their target level in 2014 and
around 3-3.5% by 2020 so businesses The biggest giveaways related to cutting
early 2015, whilst nominal wage growth
and individuals should assume that the corporation tax to 18% by 2020, further
has picked up markedly this year as past
cost of borrowing will increase increases in personal income tax
strong employment growth reduced
gradually over the next few years and allowances and extending inheritance
spare capacity in the labour market,
should stress test how such rate rises tax relief for main residences.
despite continued high levels of inward
migration of workers. will affect them financially.
These giveaways were more than
Budget confirms more fiscal tightening outweighed, however, by a series of tax
Going forward, we expect real earnings
to come over next four years increases relating to dividend taxation,
growth to continue, though this may
insurance premium tax and vehicle
moderate somewhat from 2016 as The recent Summer Budget gave more
excise duty, as well as restrictions in
inflation returns towards target, even detail of the government’s plans for
pensions tax relief and a range of
if nominal wage growth continues to further fiscal tightening to eliminate
anti-avoidance measures. By 2020, the
rise to over 3%. Despite this more the projected overall budget deficit by
OBR estimates the implied net tax rise to
positive trend, however, the level of 2019/20. The pace of spending cuts
be around £7 billion, although this would
real earnings would not be expected to has been smoothed and extended over
only be around 0.3% of GDP so its
regain itspre-crisis peak until late in an additional year, which will allow
macroeconomic impact is likely to be
this decade. affected government departments,
small compared to over £30 billion of
local authorities and households more
planned real spending cuts by 2019/20.
2.4 – Monetary and time to adjust.
fiscal policy In general, there will now be smaller
While the planned fiscal consolidation
may dampen growth in the short term,
cuts to public services spending,
Interest rates likely to start to rise however, there should be some offset
though these could still be severe for
gradually during 2016 from lower long-term interest rates. More
unprotected departments (i.e. all
So far the Monetary Policy Committee importantly, returning to a small budget
except health, schools, overseas aid
(MPC) has continued to maintain the surplus by 2020 and a clearly declining
and now defence). We will get further
Bank Rate at 0.5% and the stock of public debt to GDP ratio of just under
details of this in the Spending Review
purchased assets financed by central 70% by that time (compared to just over
in the autumn.
bank reserves (i.e. QE) at £375 billion. 80% now and less than 40% before the
The members of the MPC voted financial crisis) will give more scope for
By contrast, welfare cuts eventually
unanimously in favour of both these future UK governments to respond to
building up to around £12 billion per
decisions in June and it seems likely major adverse economic shocks.
annum will be phased in over the
they also did so in July (though we period to 2020. However, the adverse
do not know that for sure at the time The optimal longer term fiscal target to
impact of this will be offset for many
of writing). adopt is open to debate, but the need
low earners by the new National Living
for some significant additional fiscal
Wage, which is set to rise to over £9 per
Going forward, the current low rate of consolidation seems clear given that
hour by 2020 for over-25s. The OBR
headline inflation and the uncertainty the cyclically-adjusted structural
estimates that this could cost around
around Greece may cause most MPC budget deficit will still be around 3.2%
60,000 jobs, but this is only around
members to vote against interest rate of GDP this year according to the OBR.
0.2% of total UK employment and
rises for the next few months, though would be against a backdrop of
UK Economic Outlook July 2015 152.5 Summary and Under our main scenario, consumer
conclusions price inflation is forecast to average
0.3% this year, but this is largely due to
In summary, the
The UK economy slowed during the temporary factors so we would expect UK economic outlook
first quarter of 2015 from the 3% it to move back up towards its 2%
average annual rate seen in 2014, but target rate by the end of 2016. This
remains positive,
there are signs of a post-election should eventually cause the MPC to but there are still
recovery more recently. Despite the start raising interest rates gradually,
relatively slow start to 2015, we project although probably not until early 2016 downside risks
GDP growth to be around 2.6% in 2015, (though a minority of MPC members
which could still be the fastest in the could well start to vote for a rate rise
G7, with a modest further deceleration before that).
to a near trend rate of 2.4% in 2016 in
our main scenario. The July Budget set out more details of
the government’s plans to tighten fiscal
The non-financial private services policy significantly over the next four
sector remains relatively buoyant and years with a view to eliminating the
should continue to lead the UK overall budget deficit by 2019/20. The
recovery, helped by steady consumer direct effect of this may be to dampen
spending growth supported by growth somewhat, but it should also
continued employment growth and a have offsetting benefits in terms of
recent recovery in earnings growth. lower long-term interest rates than
The construction sector has cooled would otherwise be the case and giving
since mid-2014, but seems now to be more fiscal scape to respond to any
enjoying a post-election rebound. future adverse economic shocks.
The manufacturing sector has been In summary, the UK economic outlook
suffering more from ongoing sluggish remains positive, but there are still
growth in the Eurozone, as well as downside risks such as those relating
uncertainties related to Greece, though to a Greece for which affected
the impact of possible Greek euro exit businesses should make appropriate
(which is less likely, but still possible contingency plans.
after the recent proposed deal) should
not be overstated for the UK economy
as a whole. The ECB and other central
banks have better tools now to prevent
any Greek default leading to wider
financial and economic contagion and
both European banks and economies
are in better shape now than if Grexit
had occurred in 2011-12.
London and the South East are forecast
to remain the fastest growing regions
in both 2015 and 2016, with average
growth of close to 3% per annum, but
all UK regions should achieve positive
growth of over 2% per annum on
average in 2015-16, except perhaps
Northern Ireland, where average
growth is projected to be slightly lower
at around 1.7-1.8%.
16 UK Economic Outlook July 20153 – UK housing market outlook: the
continuing rise of Generation Rent
Introduction and decline to 7.2 million by 2025 as Growth in London reached an even
limited housing supply, affordability higher rate of 17.4%.
summary and mortgage availability make it
In this section we review recent trends in harder for first time buyers to get on By May 2015, in contrast, UK average
the UK housing market and present the housing ladder. house price growth had fallen to 5.7%.
projections for house price growth in the The price slowdown in London has
UK and the regions. In addition, this new • The other key tenure trend is that a been even more marked, declining to
research looks at trends in tenure (i.e. greater number of people than 4.7%. Base effects (the surge in prices a
whether people rent or own the homes ever before own their own home year ago) mean that the house price
they live in). The key findings are: outright. This now accounts for 8.4 inflation rate in London could even turn
million households or 32% of the negative during the summer, although
• House price growth in the UK has total. We expect this to rise to 10.6 we would expect this to be only
decelerated over the past year, million households, 35% of the total, temporary as the election result has
especially in London. by 2025. A key driver is the rising removed fears of a possible mansion tax
proportion of over 60 year olds in the that would have affected London much
• Nonetheless, we project that UK, who are far more likely to have more than other regions.
average UK house prices could rise paid off their mortgages.
by around 5% this year. Assuming House price growth in 2013 and 2014
that the supply of new homes • For younger generations, renting was accompanied by an expansion in
continues to be relatively sluggish, privately is now the norm and gross mortgage lending, indicating that
house prices are expected to keep many will only become home looser credit conditions helped to
growing at around this rate for the owners quite late in their adult release pent up demand. However, the
rest of this decade. In our baseline lives. A significant rise in the supply past year has seen lending weaken.
scenario, the average UK house of affordable housing might change Monthly gross mortgage lending peaked
could be worth around £360,000 this in the long run, but seems at £19 billion in July 2014, but has now
in cash terms by 2020. unlikely to occur fast enough to stem stabilised at around £16 billion a month.
the rise in Generation Rent between This is likely to be restricting demand,
• As house prices have risen and social now and 2025. contributing to the slowdown in house
housing supply remains constrained, price growth.
the number of households in the The discussion below begins by
private rented sector has more than reviewing recent housing market Another important and much publicised
doubled since 2001, rising from developments (Section 3.1) and factor is the limited amount of new
2.3 million to 5.4 million by 2014, then goes on to consider trends and housing available. Decades of declining
around 20% of the total. We project prospects for housing tenure to 2025 housebuilding continue to bite, whilst
that this trend will continue with (Section 3.2). Section 3.3 then concludes population growth has increased
an additional 1.8 million by looking at projected future UK and markedly. Over the last five years only
households becoming private regional house price prospects. Further around 140,000 homes a year have been
renters by 2025. This would take details of our modelling work are completed, well below average rates
the total to 7.2 million households – contained in a technical annex at the over the last four decades.
almost one in four of the UK total. end of the article.
The trend is particularly strong in the Rising house prices tend to have an
20-39 age group where more than half
3. 1 – Recent housing adverse effect on affordability, acting as a
will be renting privately by 2025. The natural brake on the market. But
rise of ‘Generation Rent’ will continue. market developments unprecedentedly low mortgage rates have
There has been a marked deceleration in meant that some aspects of affordability
• Fewer households will have UK house price growth so far in 2015, have been improving, despite house price
mortgages. The number of following a period of accelerating increases: mortgage payments as a
households who own their home increases since 2012. A slowdown is not proportion of income are well below their
with a mortgage fell from around 10 wholly unexpected: average UK house 2007 levels and have followed a general
million in 2001 to only around 8 price inflation was around 10% in 20141, downward trend since then (as shown in
million in 2014. We project a further far above the growth in earnings. Figure 3.2). However, as we discuss
1 ccording to the ONS’s most recent house price statistics, which we use throughout this report as our source of house price data. But most house price indices have
A
shown broadly similar trends over time, even if estimated house price inflation can sometimes vary materially across indices in the short term.
UK Economic Outlook July 2015 17further below, initial deposits have Figure 3.1. House price inflation rate, UK and London (cash terms)
become a bigger affordability problem for
20
many first time buyers. London
16
House price inflation rate (%)
12
Market commentators tend to focus
8
mostly on house prices, and we have 4
UK
updated our projections for these prices 0
in Section 3.3 below. But there is -4
another huge change underway in the -8
market that we look at first. In 2001, just -12
10% of dwellings were privately rented, -16
-20
but now this figure is almost 20%. 2007 2008 2009 2010 2011 2012 2013 2014 2015
Furthermore, the proportion of
households with a mortgage has fallen London UK
from almost 45% to under 30%. There
is a growing dichotomy in the market Source: PwC analysis of ONS data
between those who own a house
outright and aspiring buyers.2 At the
Figure 3.2. Mortgage rates and mortgage interest payments, % of take home pay
same time, the ability of people to use
the mortgage market to make the
Mortgage payments as % of mean take home pay
60 9
transition from renting to owning
8
appears to be diminishing, with 50
7
younger generations having to wait
Mortgage rates (%)
40 6
longer to buy in many cases.3
5
30
3.2 – Housing tenure in 20
4
3
2025: the continuing rise 2
of Generation Rent? 10
1
We highlight the recent shifts in UK 0 0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
tenure trends below, which can be
summarized into three broad phases. Mortgage payments as % of mean take home pay Mortgage rates
Phase 1: 1981-1990: Source: PwC analysis of Nationwide and Bank of England data
Thatcher’s mortgage boom
The 1980s offered many the chance to Phase 2: 1991-2002: continued to decline (albeit at a slower
own their own homes for the first time. Increasing outright ownership pace than in the 1980s) as council homes
The Conservative government under Mrs At the start of the decade, mortgages continued to be sold and fewer
Thatcher used Right-to-Buy as a tool to rates were driven to highs of 15% in replacements were built.
fulfil Britain’s housing aspirations and this 1990, and the ensuing recession and
was supported by extensive liberalisation house price collapse brought a swift
of the financial sector, which made end to the mortgage-driven boom of
mortgages much more widely available. the 1980s. But the following decade
This supported a significant fall in the saw increasing numbers of people
share of people living in socially rented come to own their home outright
accommodation from 33% to 25%. as the population aged and older
In their place, the number of home owners mortgages matured. During this period
with mortgages grew, from 32% to 41% owner occupied tenure grew from
by the end of the decade. around 25% in 1990 to around 30% by
2002, and social rented housing
2 A ccording to the 2013-14 English Housing Survey, 61% of private renters (2.5 million English households) stated that they expected to buy a property at some point in the future.
3 26% of private renters who indicated they expected to buy said that they expected to buy within two years, but 44% expected that it would be five years or more before
they could buy a property.
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