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North Hants June 2011

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Inspirational presentation from Nick Parsons,Head of Research, UK and Europe and Global Head FX Strategy | Wholesale Banking | National Australia Bank Limited

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North Hants June 2011

  1. 1. The UK and World Economy: Global boom, domestic gloom ’ A Presentation for clients in Yorkshire’ Nick Parsons Head of Research UK and Europe, Global Head FX Research National Australia Bank, [email_address] June 16-17 th 2011
  2. 2. The world economy
  3. 3. <ul><li>The global economy was worth 61,963,000 million US dollars at the end of 2010. </li></ul><ul><li>GDP of the wealthiest country is more than twice the second placed country and three times as much as the third. </li></ul><ul><li>The top four countries account for half the world’s GDP. </li></ul><ul><li>The United Kingdom is still the world’s 6 th largest economy </li></ul>World Source: Bloomberg, National Australia Bank Research 2010 Global economic league table (GDP USD millions) 1 United States 16,106,896 11 India 1,430,020 2 China 5,745,133 12 Spain 1,374,779 3 Japan 5,390,897 13 Australia 1,219,722 4 Germany 3,305,898 14 Mexico 1,004,042 5 France 2,555,439 15 South Korea 986,256 6 United Kingdom 2,258,565 16 Netherlands 770,312 7 Italy 2,036,687 17 Turkey 729,051 8 Brazil 2,023,528 18 Indonesia 695,059 9 Canada 1,563,664 19 Switzerland 522,435 10 Russia 1,476,912 20 Belgium 461,331
  4. 4. Advanced economies are no longer driving global GDP growth <ul><li>Up to 2000, global growth was driven largely by industrialised nations, but the sharp slowdown in activity following the dotcom bust was followed by the rise in emerging markets. </li></ul><ul><li>All three country blocs suffered a similar “V shaped” slowdown and recovery </li></ul><ul><li>The key point is that Emerging and developing economies never crossed the zero line: there was no recession </li></ul><ul><li>Going forward, industrialised countries will become much less important drivers of global growth. </li></ul>World Source: IMF WEO, National Australia Bank Research - 4 - 2 0 2 4 6 8 10 1980 1987 1994 2001 2008 Emerging and developing economies Advanced economies World GDP growth (% y/y) 2015
  5. 5. Asia and Emerging Markets are driving the global economy <ul><li>This chart of industrial output levels from 2007 – when economies were already starting to slow – is a good example of de-coupling in action, with advanced economies yet to recover to the point where industrial output has recovered from the GFC. </li></ul><ul><li>By comparison, EM and Asian economies are surging with IP in the latter up 50% from 2007. </li></ul><ul><li>Total industrial output of G7 economies and the seven largest EM economies rise above its pre-recession peak – 17 months after the downturn. Since that point G7 IP has risen 4%, while IP from Asia is up 32%. </li></ul>World Source: Bloomberg, ,National Australia Bank Research 80.0 90.0 100.0 110.0 120.0 130.0 140.0 150.0 160.0 07 08 09 10 Industrial Production (Jan 2007- 100) World Emerging markets Advanced Economies Asia
  6. 6. After sharp G10 slowdown in 2009, growth now picking up across the world <ul><li>China and India grew strongly despite global downturn. Without their contribution, world economy would have shrunk more than 2% in 2009. </li></ul><ul><li>Massive fiscal and monetary policy stimulus saw global growth rebound sharply in 2010. </li></ul><ul><li>In both 2010 and 2011, global economic growth should be back above the average of the last 25 years. </li></ul><ul><li>UK will be slowest growing major economy both in 2011 and 2012 </li></ul>World Source: National Australia Bank Research Annual Average 2007 2008 2009 2010 2011 (f) 2012 (f) US 2.1 0.4 -2.4 3.1 2.8 3.2 Japan 2.3 -1.2 -5.1 3.1 0.0 3.7 UK 2.6 0.8 -4.3 1.4 1.3 1.8 Eurozone 2.7 0.5 -4.0 1.7 2.1 1.8 Canada 2.5 0.4 -2.7 3.2 2.8 3.0 Australia 4.0 3.1 0.5 3.5 2.1 4.4 New Zealand 3.2 0.0 -1.6 2.8 1.4 3.6 China 11.8 9.5 8.7 10.5 9.3 8.2 India 9.2 7.5 6.8 8.4 8.1 7.4 Latin America 5.4 4.1 -2.0 6.5 5.0 4.0 World 5.0 3.0 -1.1 4.6 4.2 4.2
  7. 7. UK economic outlook 2011
  8. 8. Post-recession recovery has so far been in line with both of the last two <ul><li>In the first six quarters from 1981, output rose 3.1%. In 1992 it rose 2.0% and for the six quarters beginning Q4 2009 we now expect an increase of around 2.7%. </li></ul><ul><li>So, after the deepest and longest UK recession, the recovery has so far been broadly in line with the last two. </li></ul>United Kingdom Source: Datastream, National Australia Bank Research 0 0.5 1 1.5 2 2.5 3 3.5 1 2 3 4 5 6 1981 1992 2009 0 Cumulative increase (%)
  9. 9. A comparison of the last three UK recessions <ul><li>The latter stages of both previous recessions have been characterised by a mix of positive and negative growth. </li></ul><ul><li>In early 1980’s recovery, there were two quarters of zero growth. </li></ul><ul><li>In 1990-92, growth moved negative after what initially looked like recovery. </li></ul><ul><li>Weather-affected Q4 2010 currently estimated at -0.6%, Q1 2011 +0.6%. </li></ul><ul><li>Q13 from onset of recession has generally seen an acceleration of growth but not expected in Q2 2011 </li></ul>United Kingdom Source: Datastream, National Australia Bank Research - 3 - 2 - 1 0 1 2 1 2 3 4 5 6 7 8 9 10 11 12 13 14 December 1979 June 1990 March 2008 GDP q/q % change
  10. 10. Risks around the central growth forecast <ul><li>The risk profile around the central forecast is skewed to the downside given uncertainties around activity and consumer confidence in the wake of the Comprehensive Spending Review, petrol prices and VAT. </li></ul><ul><li>Upside risks centre on UK export performance and corporate profitability driving business investment. </li></ul><ul><li>Downside risks are weak personal consumption, the ongoing impact of the credit crunch on loan availability and a rapid fiscal adjustment. </li></ul>United Kingdom Source: Datastream, National Australia Bank Research GDP q/q % change -3 - 2 - 1 0 1 2 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
  11. 11. Government deficit and debt drag on growth
  12. 12. UK Debt and Deficits relative to other EU members: the starting point <ul><li>Deficits are debt are two separate concepts </li></ul><ul><li>Deficit is the total amount borrowed in any one year </li></ul><ul><li>Debt is the cumulative total of all previous deficits </li></ul><ul><li>The UK does not have a ‘debt problem’ – debt/GDP ratio is lower than the average of the euro are and broadly in line with France and Germany </li></ul><ul><li>UK problem is the deficit; the rate at which it is adding to previous debt total. </li></ul>United Kingdom Source: European Commission, National Australia Bank Research Maastricht Treaty Limits UK has 3 rd highest deficit/GDP ratio, though total debt is below EU average Gross Debt (% of GDP) 2009 Hungary Austria Belgium Bulgaria Cyprus Czech Republic Denmark Estonia Finland France Germany Greece Ireland Italy Latvia Lithuania Luxembourg Malta Netherlands Poland Portugal Slovakia Slovenia Spain Sweden UK Euro area Romania - 14.0% - 12.0% - 10.0% - 8.0% - 6.0% - 4.0% - 2.0% 0.0% 0% 20% 40% 60% 80% 100% 120% Fiscal balance (% of GDP) 2009-10 Euro average
  13. 13. UK Debt and Deficits relative to other EU members: the target <ul><li>The Coalition Government has an extremely ambitious deficit reduction programme </li></ul><ul><li>By 2014, the deficit is projected to be just 2.5% of GDP; an unprecedented degree of fiscal tightening </li></ul><ul><li>This would take it well below the average of the euro area and, ironically, mean it was the only major economy to be meeting the Maastricht Criteria </li></ul>United Kingdom Source: European Commission, National Australia Bank Research
  14. 14. HMT/OBR budget forecasts for public sector borrowing (PSBR) <ul><li>The table shows the forecasts from the Emergency Budget on 22 June 2010, the updates in the Autumn Statement and those presented in the March Budget on 23 March 2011. </li></ul><ul><li>Total borrowing in the 5 years 2010-2014 is projected to increase by £484bn, more than the £451bn estimated in June but still less than the staggering £706bn forecast in March 2010. </li></ul><ul><li>We think these PSBR projections are overoptimistic. We still look for net borrowing around £70bn in 2014-15. </li></ul>United Kingdom Source: HM Treasury, National Australia Bank Research
  15. 15. Peripheral European Bond yields surge as deficits increase <ul><li>Surge in Greek bond yields in Q1 2010 sent a warning shot across the bows for the Labour Government. Narrative shifted from ‘investing’ to deficit reduction. </li></ul><ul><li>Market reaction to Alistair Darling’s last Budget was positive, with further falls in bond yields after the General Election and the Emergency Budget in June 2010. IMF written expressions of support have subsequently help keep UK yields down. </li></ul><ul><li>Without a credible deficit reduction plan, UK bond yields would be much higher. </li></ul>United Kingdom Source: Datastream, National Australia Bank Research 2009 2010 2011 0 2 4 6 8 10 12 14 16 18 Ireland UK Greece Germany
  16. 16. Inflation
  17. 17. UK Consumer Price Inflation on an upward trend for last decade <ul><li>CPI inflation has been trending higher for over a decade. </li></ul><ul><li>In the NICE period 2000-2005 (Non-Inflationary Constant Expansion) inflation was held down by cheap Chinese exports and strength of sterling. </li></ul><ul><li>Oil-driven spike in 2008 was reversed in 2009. </li></ul><ul><li>VAT hike from 17.5% to 20% in January 2011 added around 1.2% to CPI. </li></ul><ul><li>Underlying trend of CPI inflation is still above 3.0% </li></ul>United Kingdom Source: Datastream, National Australia Bank Research 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 0 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00 5.50
  18. 18. UK Consumer Price Inflation has been 3% or higher for past 12 months <ul><li>BoE medium-term inflation target is for harmonised CPI 2% plus or minus 1%. </li></ul><ul><li>CPI has been above target for 35 out of last 41 months </li></ul><ul><li>CPI has now been 3% or higher for 17 consecutive months. </li></ul><ul><li>Increase in VAT will keep this measure above 3% for at least another 7 months. The BoE Governor will have to write at least another 3 letters to the Chancellor of the Exchequer. </li></ul>United Kingdom Source: Datastream, National Australia Bank Research 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 0 0.50 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00 5.50
  19. 19. UK CPI Forecasts – monthly and annual rates <ul><li>VAT increase added 2.1% to the prices of those goods subject to the tax. </li></ul><ul><li>Around 60% of the CPI basket is subject to VAT so the total impact is roughly (2.1 * 0.6) = +1.2% </li></ul><ul><li>The impact of this will be unwound in late 2011 and early 2012. </li></ul><ul><li>CPI after VAT unwind will still be above 2% target and may even still be above the top end of the target. </li></ul>United Kingdom Source: Office for National Statistics, National Australia Bank Research Item 2009/10 2010/11 monthly annual monthly annual January -0.2% 3.5 +0.1% 4.0 February +0.4% 3.0 +0.8% 4.4 March +0.6% 3.4 +0.3% 4.0 April +0.6% 3.7 +0.8% 4.5 May +0.2% 3.4 +0.3% 4.5 June +0.1% 3.2 +0.1% 4.3 July -0.2% 3.1 -0.2% 4.4 August +0.5% 3.1 +0.3% 4.3 September 0 3.1 +0.2% 4.6 October +0.3% 3.2 +0.3% 4.6 November +0.4% 3.3 +0.1% 4.3 December +0.6% 2.9 +0.5% 3.8
  20. 20. Private sector drag on growth
  21. 21. UK employment and unemployment <ul><li>Total employment has fallen around 700,000 since peak in early 2008. Total employment now stands around 31,300,000. </li></ul><ul><li>Claimant count unemployment rose sharply in 2008, peaking with a 138,000 increase in February 2009. </li></ul><ul><li>Three out of last four months in 2011 have seen an increase in the claimant count, though the decline in employment appears to have stabilised. </li></ul>United Kingdom Source: Datastream, National Australia Bank Research 2000 2002 2004 2006 2008 2010 -60 -40 -20 0 20 40 60 80 100 120 140 160 29.5 30.0 30.5 31.0 31.5 32.0 32.5 Total employment (mn, RHS) Monthly change in unemployment
  22. 22. UK average earnings and CPI: the squeeze on real incomes <ul><li>Average earnings growth ran consistently ahead of CPI until H2 2008. </li></ul><ul><li>Last two years have seen negative real income growth, we expect a third in 2011. </li></ul><ul><li>This phenomenon has only occurred twice before; in 1973-75 and 1931-33. </li></ul>United Kingdom Source: Datastream, National Australia Bank Research 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 -3 -2 -1 0 1 2 3 4 5 6 7 Average earnings CPI
  23. 23. UK consumer confidence recovering but remains fragile <ul><li>Consumer confidence plunged during recession and GFC but recovered sharply as interest rates were slashed. Real income squeeze has again depressed sentiment with recent bounce still leaving confidence below pre-recession levels. </li></ul><ul><li>We expect confidence to drift sideways or even lower over next 12-18 months. </li></ul>United Kingdom Source: Datastream, National Australia Bank Research 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 -40 -35 -30 -25 -20 -15 -10 -5 0 5
  24. 24. UK retail sales: slower growth has been a feature of the last decade <ul><li>Retail sales growth has been on a gradual steady decline for almost a decade. </li></ul><ul><li>Growth only briefly turned negative during GFC, with the length and depth of slump far less pronounced than in early 1990’s. </li></ul><ul><li>Base effects from strong sales in Summer 2010 mean annual rate likely to turn sharply lower now. </li></ul>United Kingdom Source: Datastream, National Australia Bank Research 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 -4 -2 0 2 4 6 8 10
  25. 25. Stagnant house prices will hit spending through lower equity withdrawal <ul><li>In the decade to 2007, households extracted cash from the housing market to fund consumption. This process was known as Mortgage Equity Withdrawal (MEW). </li></ul><ul><li>From 2000 to March 2008 £315 billion in equity was extracted. Over the past 2 years, some £47 billion has been repaid as homeowners repay borrowings. </li></ul>United Kingdom Source: Datastream, National Australia Bank Research - 6 - 4 - 2 0 2 4 6 8 10 - 12 - 8 - 4 0 4 8 12 16 20 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010 £ billions % MEW as a % of post - tax income (RHS) MEW
  26. 26. Where RICS (Chartered Surveyors) survey leads, other indices will follow <ul><li>The RICS survey tumbled to -49 in Q4 2010 but it has subsequently recovered to -21. </li></ul><ul><li>The peaking of the RICS survey in late 2006 heralded the slowdown in other surveys which began in November 2007, and it turned up 12 months in advance of other price measures. </li></ul><ul><li>The HBOS measure has now been negative y/y for 7 consecutive months and we look for further modest price falls into year-end and beyond. </li></ul>United Kingdom Source: Datastream, National Australia Bank Research % balance 2005 2006 2007 2008 2009 2010 2011 2012 2013 -20 -15 -10 -5 0 5 10 15 -100 -80 -60 -40 -20 0 20 40 60 % change year on year Halifax Nationwide RICS (RHS)
  27. 27. Mortgage approvals have rebounded from lows but historically still weak <ul><li>Mortgage approvals reached a low of just 26,600 in November 2008. The latest number was 45,200 but this is 90,000 less than the 2003 peak and well below the average of the last 20 years. </li></ul><ul><li>The lack of transactions goes hand in hand with price weakness. Tighter conditions for mortgage finance are weighing on activity and depressing prices which are lower today than 12 months ago. </li></ul>United Kingdom Source: Datastream, National Australia Bank Research 92 94 96 98 00 02 04 06 08 10 12 20 40 60 80 100 120 140 -20 -10 0 10 20 30 40 % change year on year House Prices (y/y % RHS) Mortgage Approvals 000’s
  28. 28. Interest Rates
  29. 29. UK Bank Rate at lowest level in History <ul><li>The Bank of England was created in 1694. The current Bank Rate of 0.5% is the lowest in its history. </li></ul><ul><li>In the 10 years prior to the Global Financial Crisis (GFC) Bank Rate averaged 4.9%. </li></ul><ul><li>Having passed on the chance to raise hikes in May 2011, we look for no hike before November at the earliest, possibly not before well into 2012. </li></ul>United Kingdom Source: Bank of England, National Australia Bank Research 0 2 4 6 8 10 12 14 16 18 1694 1744 1794 1844 1894 1944 1994 per cent
  30. 30. UK real interest rates at lowest level in more than 20 years <ul><li>Whether measured by Bank Rate or 1 year Libor, real interest rates are significantly negative, benefiting borrowers at the expense of savers. </li></ul><ul><li>This subsidy to borrowers has been in place for almost 30 months; ever since collapse of Lehmans. </li></ul><ul><li>Policy normalisation will gradually reverse this subsidy by raising borrowing costs, but not soon. </li></ul>United Kingdom Source: Datastream, National Australia Bank Research 88 90 92 94 96 98 00 02 04 06 08 10 -4 -2 0 2 4 6 8 10 CPI – 1y Libor CPI – Bank Rate
  31. 31. Official interest rates and bond yields have risen almost everywhere <ul><li>Official interest rates have already risen in those countries which have returned to strong growth – Australia, Brazil, China, India and throughout South East Asia. </li></ul><ul><li>Yields substantially higher in Euro peripheral sovereigns. </li></ul><ul><li>Even low growth countries have seen bond yields rise. </li></ul>United Kingdom Source: Datastream, National Australia Bank Research 10 year Bond Yields (bp) Greece 16.74% +1226 Ireland 8.60% +729 Portugal 7.08% +770 Australia 5.17% +121 Spain 5.29% +180 Italy 4.79% +109 US 2.96% +38 Norway 3.34% +54 UK 3.24% +32 Germany 3.01% +92 Official Rates Brazil 12.25% +3.50% India 6.25% +1.25% China 5.56% +0.25% Australia 4.75% +1.75% Norway 2.25% +1.00% Canada 1.00% +0.75% Sweden 1.75% +1.50% Germany 1.00% +0.25% UK 0.50% US 0-0.25%
  32. 32. UK Market interest rates rose sharply off lows, but now largely reversed <ul><li>UK market rates bottomed out in Q4 2010 </li></ul><ul><li>Since that low point, 2 year rates rose as much as 70bp. 5 year up 120bp and 10 year 105bp. Much of this rise has subsequently been reversed as official Bank Rate expectations have been revised lower and timing of first hike pushed further out. </li></ul>United Kingdom Source: Datastream, National Australia Bank Research 2009 2010 2011 1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 2 year 10 year 5 year
  33. 33. Implied rate for 3m libor on December 2012 short sterling futures <ul><li>As CPI soared after VAT increase, expectations grew of a Bank Rate hike at the May MPC meeting. </li></ul><ul><li>As Governor King has firmly resisted calls for a rate hike despite VAT contributing only 1.2% of total CPI, so expectations for UK interest rates have been revised sharply lower. </li></ul><ul><li>Futures market signalling 3m libor of just 1.54% by end-2012. </li></ul>United Kingdom Source: Datastream, National Australia Bank Research J F M A M J J A S O N D J F M A M J 1.50 2.00 2.50 3.00 3.50 4.00 4.50
  34. 34. Market pricing of rate hike at upcoming BoE MPC Meetings <ul><li>From forward dated SONIA contracts we can calculate implied probability of a base rate hike. </li></ul><ul><li>With Bank Rate 0.5%, a SONIA of 75bp would imply 100% expected probability of hike. </li></ul><ul><li>Market has pushed expectations of UK rate hike out to Q2 2012. </li></ul>United Kingdom Source: Bloomberg, National Australia Bank Research MPC Meeting SONIA rate hike probability (%) Jul 0.54% 16% Aug 0.55% 20% Sep 0.56% 24% Oct 0.60% 40% Nov 0.61% 44% Dec 0.63% 52% Jan 2012 0.68% 72% Feb 0.70% 80% Mar 0.72% 88%
  35. 35. Conclusions
  36. 36. Conclusions <ul><li>Economic growth in the developed world is likely to be relatively subdued for some time to come; the main engines of growth will be Asia and Latin America, with Japan reconstruction providing some boost in 2012. </li></ul><ul><li>We have reached the limits of fiscal and monetary stimulus, which is now being reversed. </li></ul><ul><li>Global economic recovery and massive UK public deficit would have put upward pressure on UK interest rates and bond yields in the absence of any credible deficit reduction plan. But, the deficit reduction plan itself will depress activity and weigh on housing affordability. </li></ul><ul><li>Real incomes will be pressured by subdued earnings growth, higher inflation and pre-announced changes in allowances such as Child Benefit. </li></ul><ul><li>For the UK, we expect 2011 growth of just 1.3% in 2011, rising to 1.8% in 2012. </li></ul><ul><li>Whatever banks’ willingness to lend, they still face significant challenges in terms of their ability to do so. </li></ul><ul><li>Property still takes up too great a share of banks’ balance sheets with limited capacity for additional net lending. We expect average house prices to fall around -4% in 2011. </li></ul><ul><li>The new trend of rate growth for the UK economy is likely to be 2.0 - 2.25%; almost half a percentage point lower than the average over the past decade. </li></ul>
  37. 37. Disclaimer IMPORTANT NOTICE: So far as the law and the Financial Services Authority Rules allow, National Australia Bank Ltd (&quot;the Bank&quot;) disclaims any warranty or representation as to the accuracy or reliability of the information and statements in this Document. The Bank will not be liable (whether in negligence or otherwise) for any loss or damage suffered from relying on this Document. This Document does not purport to contain all relevant information. Recipients should not rely on its contents but should make their own assessment and seek professional advice relevant to their circumstances. The Bank may have proprietary positions in the products described in this Document. This Document is for information purposes only, is not intended as an offer or solicitation, nor is it the intention of the Bank to create legal relations on the basis of the information contained in it. No part of this Document may be reproduced without the prior permission of the Bank. This Document is intended for Investment Professionals (as such term is defined in The Financial Services and Markets Act 2000 (Financial Promotion) Order 2001) and should not be passed to any other person who would be defined as a private customer by the rules of the Financial Services Authority (&quot;FSA&quot;) in the UK, or to any person who may not have experience of such matters. Issued by National Australia Bank Limited A.B.N. 12 004 044 937, 88 Wood Street, London EC2V 7QQ. Registered in England BR1924. Head Office: 500 Bourke Street, Melbourne, Victoria. Incorporated with limited liability in the State of Victoria, Australia. Authorised and regulated by the Financial Services Authority in the UK.

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