Danske Research - Danske Bank

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Jan 6, 2016 - The economy continues to perform well, although growth has slowed recently. We continue to believe the UK
Economic Research — General Market Conditions

6 January 2016

Research UK ‘Brexit’ uncertainty biggest threat to the upturn 

Although growth in the UK has slowed in recent quarters, the upturn remains on track. We still expect growth slightly above trend in coming years, driven mainly by domestic demand, as the strong GBP and weak global demand weigh on exports.



The lower oil price has lowered the inflation outlook. This is the main reason we recently moved our call for the first BoE hike to Q2 16, probably in May.



‘Brexit’ is the main risk factor for the UK economy. Higher uncertainty until the referendum may hurt the recovery.

Growth to be driven by domestic demand The economy continues to perform well, although growth has slowed recently. We continue to believe the UK will expand slightly above trend in coming years, driven mainly by domestic demand. In particular, the outlook for private consumption remains solid due to a combination of higher employment, positive real wage growth, high consumer confidence and the low oil price. The government’s fiscal consolidation plans mean that we see limited room for growth in government consumption. It seems appropriate to tighten fiscal policy, as the UK economy is expanding at a solid pace even without expansionary fiscal policy. Also, monetary policy is still extremely accommodative and will probably be tightened only very gradually. We expect investments to continue growing at a solid pace, as more private firms are close to their capacity limits and labour has become increasingly expensive. Downside risks to our forecast are the fiscal consolidation plans and the upcoming EU in/out referendum. The fiscal consolidation plans may weigh on total investments through lower government investments. The upcoming EU in/out referendum raises the issue that firms may be reluctant to invest: the possibility of a vote to ‘leave the EU’ means that the future economic environment for British firms is uncertain.

We expect the UK to continue to expand

Source: Office for National Statistics, Danske Bank

Private consumption is the main growth driver

Source: Office for National Statistics, Danske Bank

Unemployment rate will fall further

The outlook for exports remains subdued due to a combination of slow growth in the rest of Europe (the UK’s biggest export partner) and the strong sterling. Net exports are expected to pull GDP growth down in both 2016 and 2017.

Labour market one of the hot spots The UK labour market has rebounded following the slowdown in Q2 15 and the unemployment rate (3M average) fell to 5.2% in October. The single month unemployment rate was 5.08%, the lowest since May 2008. The single month unemployment rate has fallen every month since May, when it was 5.73%. Although wage growth was slower than expected in H2 15, we expect wage pressure to continue building, as we believe the labour market will continue to tighten. We believe the unemployment rate will reach 4.7% in Q4 17.

Important disclosures and certifications are contained from page 4 of this report.

Source: Office for National Statistics, Bank of England, Danske Bank Markets

Analyst Mikael Olai Milhøj +45 45 12 76 07 [email protected] Chief Economist UK Angela McGowan +44 28 9004 8658 [email protected]

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First BoE hike in Q2 Disappointing wage growth in H2 15 and the further fall in oil prices are the main reasons we recently moved our call for the first Bank of England hike to Q2 16, probably in May. The lower oil price, in particular, has lowered the inflation outlook for the UK significantly. The risk picture is in our view balanced. On one hand, the UK real economy is doing well with growth slightly above trend, increasing employment and the unemployment rate more or less back to ‘normal’. On the other, temporary factors such as the strong GBP and lately the lower oil price, in particular, are keeping inflation low and we believe they will continue to put downward pressure on CPI inflation. We expect CPI inflation to stay below 0.5% in H1 16, before moving up in H2 16. In our main scenario, under the assumption of a small rebound in oil and food prices, CPI inflation will reach 2% towards year-end 2017. As movements in oil and food prices have been very difficult to predict – and may continue to be so – we have also looked at the inflation outlook with unchanged commodity prices. Even in this scenario, headline inflation will pick up in H2 16 and eventually reach 1.7% towards the end of 2017.

CPI inflation set to reach 2% by the end of 2017

Source: Office for National Statistics, Danske Bank

Lower oil prices have lowered the inflation outlook

Even though we still expect CPI inflation to be low in May, we think that the underlying pressure on the Bank of England is still greater than currently recognised. Monetary policy works with a lag and unemployment is already more or less back to ‘normal’.

‘Brexit’ the biggest threat to the economy The EU in/out referendum is still lurking, as the negotiation talks between the UK and the EU have just begun. The uncertainty about the future relationship between the UK and the EU – and what would happen if the UK votes to leave the EU – remains the biggest threat to the UK economy in coming years. According to a recent Bloomberg survey, we share this view with 56% of the other analysts. Looking at the most recent opinion poll from YouGov, it is currently a very close race between the ‘remain’ and the ‘leave’ sides (41% each in the latest YouGov poll). However, many voters are still undecided (18%). A more detailed poll by YouGov reveals that voters are interested mainly in ‘Great control of borders and immigration from EU’ and ‘Limits on benefits EU migrants are eligible for’. ‘Greater powers for national parliaments to block EU policies’ is also important but not quite so much. YouGov has also found that there is a solid majority for remaining in the EU on renegotiated terms. Our main scenario is that the EU and UK will strike a deal good enough for the UK to vote for remaining in the UK. This is built on the assumption that the UK gets support from other northern European countries on limiting the access to welfare benefits for EU migrants. We think this is likely, as this topic is also becoming ‘hotter’ in northern European countries such as Denmark, The Netherlands, Belgium, Finland and recently even Germany. This said, we think the negotiation will be tough and we would not rule out the possibility that the UK votes to leave the EU.

Source: UK GOV, Office for National Statistics, Danske Bank

Most analysts agree that ‘Brexit’ is the biggest threat to the economy 8%

Asset bubbles/current account deficit Other

9%

Weak global growth

9%

UK fiscal policy 56%

Deterioration in UK household spending Brexit 9%

Source: Bloomberg Survey

A referendum day has still not been announced but ‘Brexit’ is likely to be a very important market theme until it is. See overleaf for an overview of our UK macro forecasts.

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9%

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UK macro forecasts 2016

% change q/q

2017

Calendar year average

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

2015

2016

2017

GDP

0.6

0.6

0.6

0.6

0.5

0.5

0.5

0.5

2.2

2.4

2.3

Private consumption

0.8

0.8

0.8

0.8

0.6

0.6

0.6

0.6

2.9

3.1

2.6

Government consumption

0.1

0.1

0.1

0.1

0.0

0.0

0.0

0.0

1.6

0.8

0.1

Fixed investments

1.0

1.0

1.0

1.0

1.1

1.1

1.1

1.1

4.5

4.4

4.3

Exports

1.0

1.0

1.0

1.0

1.0

1.0

1.0

1.0

5.3

3.1

4.1

Imports

1.1

1.1

1.1

1.1

1.0

1.0

1.0

1.0

5.7

3.6

4.2

Domestic demand1

0.7

0.7

0.7

0.7

0.6

0.6

0.6

0.6

2.9

2.8

2.4

-0.1

-0.1

-0.1

-0.1

0.0

0.0

0.0

0.0

-0.3

-0.3

-0.2

Net exports

1

Inventories1

0.0

0.0

0.0

0.0

0.0

0.0

0.0

0.0

-0.4

-0.2

0.0

Unemployment rate (%)

5.2

5.1

5.0

5.0

4.9

4.9

4.8

4.7

5.4

5.1

4.8

CPI (% y/y)

0.4

0.4

0.8

1.3

1.8

1.9

1.9

1.9

0.0

0.7

1.9

Core CPI (% y/y)

1.3

1.5

1.4

1.6

1.8

1.9

2.0

2.2

1.1

1.4

1.9

Public budget 2 Public debt

2

Current account 3 BoE Bank Rate (%) (end of period)

4

0.50

0.75

1.00

1.00

1.25

1.50

1.75

1.75

-3.9

-2.5

-1.3

87.1

86.5

84.8

-4.5

-4.0

-3.5

0.50

1.00

1.75

1. Contribution to GDP growth 2. % of GDP, Office for Budget Responsibility forecasts 3. % of GDP, EU commission forecast 4. End of period Source: Office for National Statistics, Office for Budget Responsibility, Eurostat, EU commission, Danske Bank Markets

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Disclosures This research report has been prepared by Danske Bank Markets, a division of Danske Bank A/S (‘Danske Bank’). The authors of the research report are Mikael Olai Milhøj, Analyst, and Angela McGowan, Chief Economist UK. Analyst certification Each research analyst responsible for the content of this research report certifies that the views expressed in the research report accurately reflect the research analyst’s personal view about the financial instruments and issuers covered by the research report. Each responsible research analyst further certifies that no part of the compensation of the research analyst was, is or will be, directly or indirectly, related to the specific recommendations expressed in the research report. Regulation Danske Bank is authorised and subject to regulation by the Danish Financial Supervisory Authority and is subject to the rules and regulation of the relevant regulators in all other jurisdictions where it conducts business. Danske Bank is subject to limited regulation by the Financial Conduct Authority and the Prudential Regulation Authority (UK). Details on the extent of the regulation by the Financial Conduct Authority and the Prudential Regulation Authority are available from Danske Bank on request. The research reports of Danske Bank are prepared in accordance with the Danish Society of Financial Analysts’ rules of ethics and the recommendations of the Danish Securities Dealers Association. Conflicts of interest Danske Bank has established procedures to prevent conflicts of interest and to ensure the provision of highquality research based on research objectivity and independence. These procedures are documented in Danske Bank’s research policies. Employees within Danske Bank’s Research Departments have been instructed that any request that might impair the objectivity and independence of research shall be referred to Research Management and the Compliance Department. Danske Bank’s Research Departments are organised independently from and do not report to other business areas within Danske Bank. Research analysts are remunerated in part based on the overall profitability of Danske Bank, which includes investment banking revenues, but do not receive bonuses or other remuneration linked to specific corporate finance or debt capital transactions. Financial models and/or methodology used in this research report Calculations and presentations in this research report are based on standard econometric tools and methodology as well as publicly available statistics for each individual security, issuer and/or country. Documentation can be obtained from the authors on request. Risk warning Major risks connected with recommendations or opinions in this research report, including a sensitivity analysis of relevant assumptions, are stated throughout the text. Date of first publication See the front page of this research report for the date of first publication.

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