UK Economic Outlook July 2015 - UK housing market outlook: the continuing rise of Generation Rent

 
UK Economic Outlook July 2015 - UK housing market outlook: the continuing rise of Generation Rent
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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UK Economic Outlook July 2015 - UK housing market outlook: the continuing rise of Generation Rent
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
UK Economic Outlook July 2015 - UK housing market outlook: the continuing rise of Generation Rent
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      3
1 – 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 2015
Higher 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                    5
Increasing 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 2015
2 – 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      7
2.1 – 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 2015
first 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           9
past 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 2015
2.2 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                 11
Figure 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 2015
Table 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                13
2.3 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 2015
A 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    15
2.5 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 2015
3 – 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                17
further 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.
18    UK Economic Outlook July 2015
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