Green Budget: The Economic Outlook January 30 th 2008 David Miles, Chief UK Economist David. Miles@morganstanley. com Morgan Stanley does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Please see important disclosures at the end of this report.
Summary A worse outlook than for some time: our central forecast is for two years of below trend growth Weaker consumer spending for the next few years Slower growth in the economies of the UK’s major trading partners We forecast weaker GDP growth than the Treasury in 2008– 09 and 2009– 10. Thereafter, we project slightly stronger growth than the Treasury David Miles, david. miles@morganstanley. com 2
Figure 4. 1. Economic growth and inflation since 1957 David Miles, david. miles@morganstanley. com Source: ONS 3
Near-term outlook: consumer spending key David Miles, david. miles@morganstanley. com 4
Figure 4. 3. Saving rate 12 Overall 10 Excluding change in net equity of households in pension schemes Saving rate (%) 8 6 4 2 0 Q 1 2007 Q 1 2006 Q 1 2005 Q 1 2004 Q 1 2003 Q 1 2002 Q 1 2001 Q 1 2000 Q 1 1999 Q 1 1998 Q 1 1997 Q 1 1996 Q 1 1995 -2 Sources: ONS; Morgan Stanley Research. David Miles, david. miles@morganstanley. com 5
Figure 4. 4. Household gross financial liabilities 175 1995 2005 % of disposable income 150 125 100 75 50 25 0 UK US Germany France Italy Spain Sources: Eurostat; Federal Reserve; BEA; Morgan Stanley Research. David Miles, david. miles@morganstanley. com 6
Figure 4. 6. Debt servicing and interest rates 18 Debt servicing a % of disposable income (MIRAS adjusted) Bank of England base rate 16 14 Per cent 12 10 8 6 4 2 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 0 Notes: Debt servicing is interest payments b y households and regular payment of mortgage principal. MIRAS is mortgage interest tax relief (phased out during the 1990 s). Sources: Bank of England, ONS; Inland Revenue; Morgan Stanley Research. David Miles, david. miles@morganstanley. com 7
Figure 4. 2. Real consumer spending growth 7 Real household sector consumer spending % change over year 6 Average since 1956 5 4 forecast 3 2 1 Q 1 -09 E Q 1 -08 E Q 1 -07 Q 1 -06 Q 1 -05 Q 1 -04 Q 1 -03 Q 1 -02 Q 1 -01 Q 1 -00 Q 1 -99 Q 1 -98 Q 1 -97 Q 1 -96 0 Sources: ONS; Morgan Stanley Research. E = Morgan Stanley Research forecast David Miles, david. miles@morganstanley. com 8
Inflation and interest rates David Miles, david. miles@morganstanley. com 9
Output gap (% of potential output) Figure 4. 14. Cyclical fluctuations in the UK economy since 1972 6 5 4 3 2 1 0 -1 -2 -3 -4 -5 -6 -7 Q 1 1972 HP Filter (lambda=1, 600) Output is above trend HP Filter (lambda=6, 000) HMT output gap (PBR 2007) Christiano-Fitzgerald Output is below trend Q 1 1977 Q 1 1982 Q 1 1987 Q 1 1992 Q 1 1997 Q 1 2002 Q 1 2007 Sources: ONS; HM Treasury; Morgan Stanley Research. David Miles, david. miles@morganstanley. com 10
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Long-term prospects: The supply side David Miles, david. miles@morganstanley. com 13
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Risks and forecasts David Miles, david. miles@morganstanley. com 15
Figure 4. 12. House prices relative to average household disposable income ratio 7. 0 Average house price divided by average disposable income per household 6. 0 5. 0 4. 0 3. 0 Q 1 2007 Q 1 2006 Q 1 2005 Q 1 2004 Q 1 2003 Q 1 2002 Q 1 2001 Q 1 2000 Q 1 1999 Q 1 1998 Q 1 1997 Q 1 1996 Q 1 1995 Q 1 1994 Q 1 1993 Q 1 1992 Q 1 1991 Q 1 1990 Q 1 1989 Q 1 1988 Q 1 1987 Q 1 1986 Q 1 1985 Q 1 1984 Q 1 1983 2. 0 Notes: Average house price uses HBo. S series. Average disposable income uses aggregate disposable income of r the household secto divided by the (interpolated) number of households. Source: ONS, HBo. S, DCLG, Morgan Stanley research David Miles, david. miles@morganstanley. com 16
Figure 6. 14: The effective mortgage spread 150 0 Effective mortgage spread (LHS, a) 120 Herfindahl index(b) (RHS, c) 0. 02 Basis points 0. 04 60 0. 06 Index 90 Increased competition 30 0 2000 0. 08 0. 1 2002 2003 2004 2005 2006 2007 Sources: Bank of England Bank calculations (a) Effective interest rate on the stock of outstanding mortgages relative to an appropriate funding rate. For floating-rate mortgages, that is ass umed to be Bank Rate. For fixed -rate products, swap rates of similar maturities are used (averaged over the relevant horizon and lagged one month). (b) The Herfindahl index is a measure of concentration in an industry or sector. It is calculated as the sum of the squares of market shares for each firm. (c) Inverted scale. David Miles, david. miles@morganstanley. com 17
Table 6. 8 Bank Securitisation of Mortgage Loans Total mortgage loans outstanding Securitised 2006 (£bn) (%) HBOS 219. 0 72. 7 33 Abbey 101. 7 29. 1 29 Lloyds TSB 95. 3 14. 9 16 Northern Rock 77. 3 47. 2 61 RBS 69. 7 15. 7 23 Barclays 61. 7 12. 6 20 HSBC 37. 4 3. 7 10 Alliance & Leicester 38. 0 3. 4 9 Bradford & Bingley 31. 1 6. 7 22 731. 2 206. 0 28 Total Source: Company data, Morgan Stanley Research David Miles, david. miles@morganstanley. com 18
Figure 4. 17. Alternative GDP growth scenarios Morgan Stanley pessimistic case real GDP projection 4. 0 % change year-on-year 4. 5 Morgan Stanley central case real GDP projection HM Treasury (real GDP growth assumption used in fiscal projections) 3. 5 3. 0 2. 5 2. 0 1. 5 1. 0 0. 5 2012 -13 2011 -12 2010 -11 2009 -10 2008 -09 2007 -08 2006 -07 2005 -06 2004 -05 0. 0 Sources: HM Treasury; Morgan Stanley Research. David Miles, david. miles@morganstanley. com 19
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