Economic Outlook:

Challenges of the coming cycle

Ian McCafferty

Chief Economic Adviser

CBI

The shape of the recovery?

• Pattern of recovery

• U, V, W, √ ?

• Financial recessions

linger

• Impact of the financial crisis

on long term performance

• Desynchronised recoverySource: IMF

0 1 2 3 4 5 6 7 8

Fiscal policy contraction

Monetary policy tightens

Oil shocks

External demand shock

Financial crises

Big 5 financial crises

Output loss % from peak

Duration (quarters)

Shocks and Recessions

Rebound from RecessionGDP

0.0

0.5

1.0

1.5

2.0

2.5

3.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

1995 1997 1999 2001 2003 2005 2007

World GDP growth & inflation% yoy

?

-5

-4

-3

-2

-1

0

1

2

3

4

5

6

2005 2006 2007 2008 2009

US UK Eurozone

-10

-5

0

5

10

15

20

2001 2002 2003 2004 2005 2006 2007 2008 2009

Eurozone UK USA

Bank Lending to Private Sector%yoy

-30

-20

-10

0

10

20

30

40

2001 2002 2003 2004 2005 2006 2007 2008 2009

UK US Eurozone

Corporate Profitability%yoy

Productivity% yoy

The coming cycle: access to finance

• Flow of capital from banks still constrained

• Productivity recovering, and corporate

profits being rebuilt

The coming cycle: fiscal challenge

Structural Budget Deficits in 2010

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

OECD North America Eurozone

Government Debt Issuance

2007

2008

2009

2010

USD Trillions

0

2

4

6

8

10

12

14

16

UK USA Germany

2007

2014

Net Interest Payments

% of Fiscal Revenue

% GDP

-9

-8

-7

-6

-5

-4

-3

-2

-1

0

UK US Japan France Germany

• Large structural budget deficits

• Dramatic increase in govt debt issuance

• Concerns over crowding out

• Upward pressure on yields

• Downgrades and defaults?

• Impact on the euro?

Source: IMF Source: OECD

Source: IMF

-6

-5

-4

-3

-2

-1

0

1

2

3 UK US Eurozone

The coming cycle: inflation or deflation?

• Underlying conditions deflationary

• Spare capacity – output gaps

• High unemployment holding down wages

• Some inflation concerns in LDCs (India,

Russia, Turkey) but not widespread

• But higher energy and metals prices

• Policy error? or intention?

• Central Bank independence -3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

2001 2002 2003 2004 2005 2006 2007 2008 2009

UK US Eurozone

CPI Inflation

0

50

100

150

200

250

300

350

400

450

500

Commodity prices (2003=100)

Food Metals Oil

Output Gaps% of potential GDP

% yoy

Source: IMF

Global outlook 2010-2011

2010-2011: strengthening, but

unbalanced growth

• Recession over, but global economy short of

full health

• Less synchronised recovery

• G3 constrained by legacies of credit

crunch

• EMEs picking up rapidly

Risks/potential weaknesses

• Elevated degree of uncertainty

• Structural imbalances pose threats to

sustainability of recovery

• Coordinated fiscal tightening

• Sovereign debt risk

• Economic nationalism

• Raw material prices

• Financial market volatility

Forecasts

World GDP Growth – by Major Region

2009 2010 2011

World -0.9 3.7 4.3

Advanced economies -3.0 2.1 2.5

Developing economies:

Africa 2.7 3.5 5.0

Latin America -0.5 3.8 4.5

China 8.7 9.6 9.2

India 6.7 7.3 8.8

World GDP Growth% yoy

Improving UK economic news

• Two quarters of positive GDP

• Inventory cycle turning

• Confidence improving

• Housing market stabilised

• Prospects for Q2 look good

• Improving export orders

• Industrial production picking up

• Consumer spending improving

• Outlook into 2011?

CBI forecast

UK GDP% qoq

-35

-30

-25

-20

-15

-10

-5

0

+5

+10

+15

Raw materials Work in progress Finished goods

CBI Industrial Trends Survey

Volume of stocks% balance

% qoq oya % q/q oya

UK: Exports

2010: positive contribution

• Global economy recovering

• Unsynchronised recovery

• EMEs picking up rapidly

• EU12: already emerging from

recession

• US: bottoming out

• Weaker sterling will help competitiveness

70

75

80

85

90

95

100

105

110

2004 2005 2006 2007 2008 2009 2010

Sterling EER

UK exports

Goods (lhs)

Services (rhs)

Jan

2005=100Manufacturing export orders

% balance

CBI Industrial Trends Survey

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

9.0

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

-1.0

1.0

3.0

5.0

7.0

9.0

11.0

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

UK: Consumer spending constrained

CBI forecastCBI forecast

Consumer spending%qoq

Savings ratio%

Unemployment rate%

CBI Forecast

GfK Consumer confidence% balance

UK: Investment headwinds

Residential investmentBusiness investment

Constraints on investment Industrial Trends Survey –

investment intentions% balance

% qoq oya% qoq oya

%

UK public finances

Past 4.2% real pa

Now & future real 1.2% pa

• Dramatic deterioration in fiscal position

• 2010-11: spending up to 48%, taxes

down to 35% of GDP

• Structural deficit to hit 9% of GDP

• UK debt to double to 80% by 2014

• Political uncertainty; sovereign debt rating

at risk; risk to sterling?

• Fiscal austerity to come

Growth in planned public spending

% of GDP

Real % rise

-2

0

2

4

6

8

10

12

14

Public sector net borrowingStructural Cyclical

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

90.0

1974/7

5

1979/8

0

1984/8

5

1989/9

0

1994/9

5

1999/0

0

2004/0

5

20

09

/10

20

14

/15

Net debt% GDP

*figures from 2015/16 onwards are CBI estimates

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

2006 2007 2008 2009 2010

UK Inflation & Monetary Policy

Consumer prices%yoy

£ Billion

• CPI inflation forecast to be below target

by end of 2010 and throughout 2011

• Risks of higher energy and commodity

prices

• Price pressures vs spare capacity

• Monetary policy likely to remain easy

• Unwinding of QE: when and how?

Reserve Balances at BoE

0

20

40

60

80

100

120

140

160

180

2006 2007 2008 2009 2010

Output Price of Manufactured Goods%yoy

Source: Haver Analytics

UK overview 2010-11

2010/11: Recovery to be sluggish

• Few obvious sources of domestic demand

growth in near term

• Business investment weak

• Fiscal austerity

• Shift in consumer behaviour?

• Sterling weakness to boost exports

• Credit constraints still a concern

• Firmer growth rates after unemployment

peaks in autumn

Forecasts2009 2010 2011

GDP -4.9 1.0 2.5

Household Consumption -3.1 0.7 1.9

Manufacturing output -10.5 1.4 2.3

Consumer Prices 2.2 2.4 1.6

Unemployment (%) 7.6 8.5 8.3

UK GDP% yoy

Comparison of recessions and recoveriesCumulative GDP %

change from peak

Time in quarters, peak GDP = 1

Economic Outlook

Ian McCafferty

Chief Economic Adviser

CBI