UK Economy: Where do we go from here? Robert Gardner, Head of Macroeconomics

Slide 2

What to expect in the next 30 mins: Taking stock:

– A simple framework for thinking about the future– Where we are and where we are heading (......probably)

What does it mean for businesses?– Demand conditions at home and abroad– Pricing power– Interest rates

Q&A

Slide 3

A simple analytical framework.....

Higher Capacity, Higher Trend Growth

Lower Capacity, Lower Trend Growth

High Policy Traction

Low Policy Traction

Slide 4

Our central forecast

"Slow Grind Higher"• Deep downturn, slow recovery• Low inflation • Gradual policy normalisation• De-leveraging: slow and painful

"Return of Macro Instability"• Quick return to growth, • No slack, volatile inflation, interest rates• Return to “boom-bust” cycle• De-leveraging: disorderly

"Goldilocks Returns"

"Deflation"• Very deep downturn (-10%) then stagnation• Deflation• No scope for policy normalisation• De-leveraging: frustrated

Higher Capacity, Higher Trend Growth

Lower Capacity, Lower Trend Growth

High Policy Traction

Low Policy Traction

• Quick recovery, robust growth, • Plenty of slack• Low inflation• Steady Policy Normalisation• De-leveraging: quick and smooth

Slide 5

Slow grind higher.....

92

94

96

98

100

102

104

2008

2009

2010

2011

2012

2013

UK Economic Output (Index Start of Recession Q1 2008 = 100)

Current position

3 Years to make up the ground we've lost

Source: ONS, RBS Group Economics

Slide 6

Demand conditions

Slide 7

The hit to households was enormous

-20%

-15%

-10%

-5%

0%

5%

10%

Financial Housing Total Debt Net Worth

UK Household Balance sheets(% change since Q3 2007 peak)

-509bn -520bn -1029bn

+72bn

-1100bn

Source: Thomson Datastream

Slide 8

Repairing balance sheets won’t be quick or painless

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.019

9019

9119

9219

9319

9419

9519

9619

9719

9819

9920

0020

0120

0220

0320

0420

0520

0620

0720

0820

0920

1020

1120

1220

1320

14

ForecastUK Household Saving Ratio (%)

Source: ONS, RBS Group Economics

Slide 9

Labour market – tough, but not as tough as before

92

94

96

98

100

102

104

106

t

t+4

t+8

t+12

t+16

t+20

t+24

t+28

t+32

t+36

t+40

t+44

UK Employment levels (Index, Start of recession = 100)

1979 1990

2008

Current Position

Source: ONS, RBS Group Economics

Slide 10

Back to balance?

57

58

59

60

61

62

63

64

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

Forecast

Consumer Spending/Total Spending (%)

Source: ONS, RBS Group Economics

Slide 11

Re-stocking likely to provide something of a lift....

-20000

-15000

-10000

-5000

0

5000

1000019

77

1980

1984

1987

1991

1994

1998

2001

2005

2008

Stock Liquidation

Stock Accumulation

Savage cuts in inventories

Change in UK Firms' Inventories (£mn, constant prices)

Source: ONS

Slide 12

Capex likely to remain subdued

Capacity Utilisation Rates (%)

70

72

74

76

78

80

82

84

86

88

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

Source: CBI

Slide 13

Good news for exporters: global demand prospects are brighter

0.0

1.0

2.0

3.0

4.0

5.0

6.0

UK Eurozone US Eastern Eur LatinAmerica

Asia

2010 2011

Consensus Growth Forecasts (%)

Source: Consensus Economics (March 2010 Survey)

Slide 14

A competitive exchange rate will also help.....

1.30

1.40

1.50

1.60

1.70

1.80

1.90

2.00

2.10Q

1 19

88Q

1 19

89Q

1 19

90Q

1 19

91Q

1 19

92Q

1 19

93Q

1 19

94Q

1 19

95Q

1 19

96Q

1 19

97Q

1 19

98Q

1 19

99Q

1 20

00Q

1 20

01Q

1 20

02Q

1 20

03Q

1 20

04Q

1 20

05Q

1 20

06Q

1 20

07Q

1 20

08Q

1 20

09Q

1 20

10

Dollar/Sterling through time

PPP (Based on WPI)

Source: Thomson Datastream, RBS Group Economics

Slide 15

When households/firms are fixed, there’s still work to do...

-10.0

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

1989

-90

1991

-92

1993

-94

1995

-96

1997

-98

1999

-00

2001

-02

2003

-04

2005

-06

2007

-08

2009

-10

UK Fiscal Deficit (% of GDP)

Source: HM Treasury

Slide 16

Pricing Power & Margins

Slide 17

Weak demand points to a lack of pricing power

0.0

1.0

2.0

3.0

4.0

5.0

2004

2005

2006

2007

2008

2009

2010

2011

2012

CPI Inflation (%)

Forecast

MPC Target

Source: ONS, RBS Group Economics

Slide 18

Margins under pressure? Exchange rates, commodities

507090

110130150170190210230

Jun

05

Oct

05

Feb

06

Jun

06

Oct

06

Feb

07

Jun

07

Oct

07

Feb

08

Jun

08

Oct

08

Feb

09

Jun

09

Oct

09

Feb

10

Commodity Prices (Index 2006=100)

Oil

All Commodities

Source: Thomson Datastream

Slide 19

Labour market softness = weak wage growth

0.0

1.0

2.0

3.0

4.0

5.0

6.0

2001 2002 2003 2004 2005 2006 2007 2008 2009

Average Earnings (% y/y)

Source: ONS

Slide 20

Profits haven’t been hit as hard as you might have expected

-35.0

-30.0

-25.0

-20.0

-15.0

-10.0

-5.0

0.02008 to date 1990s 1980s

Decline in UK Non-oil Non Financial Trading Profits from peak (%, Real Terms, Deflated using GDP deflator)

Source: ONS

Slide 21

Productivity trends are not encouraging....

95

97

99

101

103

105

107

109

111

2007 2008 2009

US

UK

Productivity (Output per hour worked, Index 2007=100)

Source: ONS, US Bureau of Labor Statistics

Slide 22

Interest rates

Slide 23

Base rates – slow to move, but don’t get caught out...

0

1

2

3

4

5

Q1 2010 Q1 2011 Q1 2012 Q1 2013 Q1 2014

Short-term rates (%)Base Case

Futures

Source: Bloomberg, RBS Group Economics

Slide 24

Interest rate sensitivity may be increasing.....

20

25

30

35

40

45

50

2004 2005 2006 2007 2008 2009

Fixed Rate Debt/ Total Debt (%)

50

55

60

65

70

75

80

85

2004 2005 2006 2007 2008 2009

Less than 1 Year/ Total Debt (%)

Source: Bank of England

Slide 25

In summary: tough but more sustainable Need to repair balance sheets drives our forecast

– Gradual recovery expected - a “slow grind higher” Demand conditions: likely to be tough

– Households, business, public sector all under pressure– Export potential – especially to emerging markets

Pricing power: restricted for most– Weak demand = reduced bargaining power– Sterling, commodities - potential for margin pressure– But it cuts both ways – suppliers and wage costs

Policy: central banks deliberately behind the curve– But long rates likely to move first – don’t get caught out

Slide 26

Keep in touch

Slide 27

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