Dr Andrew SentanceFormer MemberMonetary Policy Committee

The global and UK economic outlook

Presentation at Citywire Investment Conference, 1st December 2011

Outline

Why has the global economy slowed?

Resolving the euro area crisis

Key issues shaping the recovery

UK and global economic outlook

World economic growth

* EU, US and 11 other economies accounting for 85% of world GDP

Source: IMF World Economic Outlook Update, June 2011, and OECD Economic Outlook

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

-3-2-10123456

IMF, Jun 2011 OECD, Nov 2011 Ave 1990-2010

% per annum change in GDP in G-13 economies*

The rise of Asia

*: Includes Australia, China, India, Indonesia, Japan, Malaysia, Singapore, South Korea, Taiwan Province of China and Thailand.

Source: IMF World Economic Outlook

Percentage share of world GDP, current market prices and exchange rates

0%

5%

10%

15%

20%

25%

30%

35%

40%

1980 1990 2000 2010

US EU-27 Asia-pacific G10 *

Why is global growth slowing?

• Policy tightening in Asia-Pacific in response to inflationary concerns

• Financial volatility and euro area problems affecting business and consumer confidence

• Relatively high inflation squeezing disposable income and consumer spending

• Structural factors continuing to hold back growth in US and other western economies

Global inflation on the rise

% per annum change in consumer prices

Source: The Economist

USEu

ro

China

Japa

n UK

Braz

il CaIn

dia

Russia

Aust

r...

-2

0

2

4

6

8

10

12

Sep-10Sep-11

Forces underpinning global inflation

• End of global disinflationary decade

• Strong growth in late 2000s

• Global stimulus in 2009/10

• Tension from East-West rebalancing

• Assymmetric monetary policy responses

Global disinflation ends in mid-2000s

Source: Office for National Statistics

Jan-97 Jan-02 Jan-07-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

CPI goods Factory gate prices

% per annum change in UK goods prices

Global primary energy consumption

Source: BP Statistical Review 2010

Million tonnes oil equivalent

2000

2500

3000

3500

4000

4500

5000

5500

6000

6500

1980 1983 1986 1989 1992 1995 1998 2001 2004 2007

OECD

Non-OECD

Shares of world GDP and population

*: Apac G10: Asia-Pacific G10, including Australia, China, India, Indonesia, Japan, Malaysia, Singapore, South Korea, Taiwan Province of China and Thailand.

Source: IMF World Economic Outlook, World Bank and Eurostat.

2010 figures

US, 23%

EU-27, 26% Apac

G10*, 27%

Other, 24%

GDP at market prices

US, 5%

EU-27, 7%

Apac G10*, 46%

Other, 43%

Population

Problems with global monetary policy

• Tailwind of global disinflation is no longer helping to maintain price stability

• Asia and other emerging market economies are strongly growth-oriented

• Other western authorities (especially US and UK) using monetary policy to cushion structural adjustment post-financial crisis

• Energy and commodity price inflation treated as “one-off” or someone else’s problem

• Risk of inflationary bias to global monetary policy

Public debts and deficits compared

% of GDP in 2010

Source: IMF, April 2011 World Economic Outlook

Net debt0

20

40

60

80

100

120

140

64.4 64.8 69.4

117.5

Euro US UK Japan

Gov't deficits0

2

4

6

8

10

12

6.1

10.6 10.4 10.3

Budget deficits in US, UK and euro area

Source: OECD

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 20130

2

4

6

8

10

12

14

UK Euro US

General government borrowing, % of GDP

Fixing the euro “deficit problem”

• High deficit economies to show commitment to the “hard grind” of fiscal consolidation

• Strong medium term fiscal rules and effective mechanism for mutual support

• Clarifying and strengthening role of ECB

• Recapitalising and restructuring banks

• Better communication, co-ordination and market management

Will the euro area break up?

• Likely to make problems worse not better

• Practical, institutional and political issues

• Departing currencies would lack credibility

• Leaving euro would not help weaker economies address structural problems

• Policy “failure” would have severe adverse knock-on impact on all EU economies (including non-euro members such as UK)

UK economic growth

Source: ONS

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011-8

-6

-4

-2

0

2

4

6

Previous data Latest data Trend

% per annum change in non-oil GDP

The progress of the UK recovery

• Growth has slowed after initial rebound

• This partly reflects broader global slowdown and fading impact of stimulus measures

• But it is also due to a squeeze on consumers from high inflation, including VAT impact

• Pressures on consumer should ease next year but spending likely to remain subdued

• Global economic situation and resilience of business investment hold key to UK outlook

High inflation squeezing spending

Source: Office for National Statistics

1997MAR 1999FEB 2001JAN 2002DEC2004NOV2006OCT 2008SEP 2010AUG-2

0

2

4

6

8

10

Value Volume Average 97-08

% per annum growth in retail sales (3-month ave)

UK inflation stubbornly above target

Source: Office for National Statistics

1995 Jan 1997 Apr 1999 Jul 2001 Oct 2004 Jan 2006 Apr 2008 Jul 2010 Oct0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

Value Target Ave 2008-11

% per annum increase in consumer prices index

Broad-based rise in consumer prices

Source: Office for National Statistics

Food and non-alcoholic beverages

Alcoholic beverages and tobacco

Clothing and footwear

Housing, water and energy

Furniture & household eqpt/maint'ce

Health

Transport

Communication

Recreation and culture

Education

Restaurants and hotels

Miscellaneous goods and services

-2 0 2 4 6 8 10

% annual rise in CPI categories, October 2011

The MPC Inflation Record

Source: Office of National Statistics

Period Target High Low Ave

May 1997 - Dec 2003

RPIX = 2.5% 3.2% 1.5% 2.4%

Jan 2004 - Dec 2007

CPI = 2.0% 3.1% 1.1% 2.0%

Jan 2008 – Sep 2011

CPI = 2.0% 5.2% 1.1% 3.4%

Large official inflation forecast errors

Source: Bank of England

Mean of forecast percentage annual increases in consumer prices

0

1

2

3

4

5

6

2007 2008 2009 2010 2011 2012 2013

May-09 Nov-09

May-10 Nov-10

May-11 Actual CPI inflation

Why has UK inflation been so high?

• Global inflationary pressures

• Large sterling depreciation

• Persistent services inflation

• Limited impact of spare capacity

• MPC response to financial crisis

The global economy and UK inflation

Global economy

Cost of imports

Demand

Pricing climate

Exchange rate

Domestic demand

Expectations and credibility

UK inflation

Impact of monetary policy

Sterling depreciation since 2007

Rebased to 100 in January 2005

Source: Thompson Datastream and Bank for International Settlements

*: Effective exchange rate

70

75

80

85

90

95

100

105

110

2005 2006 2007 2008 2009 2010 2011

Euro-Sterling exchange rate

Sterling EER *

Average EER *, 97-07

Episodes of Sterling depreciation

Index, base year = 100

Number of years from start of period

Source: Bank for International Settlements

50

60

70

80

90

100

110

0 1 2 3 4 5

1967-1971 1972-1977 1981-1986

1991-1996 2007-2010

Euro/UK inflation differential & exchange rate

Source: Thompson Datastream

*: Euro-Sterling exchange rate is expressed as the deviation from its average over the same period.

-0.4

-0.3

-0.2

-0.1

0

0.1

0.2

0.3

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

1997 1999 2001 2003 2005 2007 2009 2011

Euro-area/UK CPI differential (RHS) *

Euro-Sterling exchange rate (LHS) **

Euro/ sterling %

Persistently high UK services inflation

Source: Office for National Statistics

Jan-97 Jan-02 Jan-07-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

Goods Services

% per annum change in UK consumer prices

Capacity utilisation in UK economy

Source: Bank of England

Jan-98 Jan-03 Jan-08-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

Manufacturing Services

Bank of England Agents’ scores relative to normal

Unemployment in UK recessions

Source: Office for National Statistics, Labour Force Survey

-8 -6 -4 -2 0 2 4 6 8 10 12 14 164

5

6

7

8

9

10

11

12

77Q4-83Q4 88Q2-94Q2 06Q2-11Q3

Unemployment rate, % of labour force

Number of quarters from employment peak

Problems with the MPC

• Emphasis on forecast has allowed the Committee to redefine its own target

• Persistent modelling and forecasting errors, with excessive weight on “output gap” model

• Assymmetric policy response

• “Benign neglect” of sterling and policy of talking down the pound

• Lack of effective scrutiny and accountability

• Perception that inflation target has been downgraded and that growth is now the focus of monetary policy

Key issues shaping the recovery

• Legacy of financial crisis, holding back spending growth in western economies

• The rise of Asia and emergence as a major engine of global growth

• High and volatile energy and commodity prices, leading to bursts of global inflation

• Uncertainty about policy-making and lack of economic leadership fuelling financial volatility and affecting confidence

Outlook for advanced economies

Source: OECD and Office for Budget Responsibility

2011 2012 20130

0.5

1

1.5

2

2.5

3

US UK Euro OECD

% per annum change in GDP

UK GDP and consumer prospects

Source: ONS and Office for Budget Responsibility

2000-08 ave

2009 2010 2011 2012 2013-5

-4

-3

-2

-1

0

1

2

3

4

GDP Consumer spending

% per annum change – latest OBR forecast

Can growth recover in 2012?

• Easing pressure on consumers from fall-back in inflation

• Global growth to pick up as Asian economies recover momentum

• Some resolution of euro area situation and reduction in financial volatility

• Confidence-building measures from policy-makers

• Resilience of UK non-financial private sector

Employment in UK recessions

Source: Office for National Statistics, Labour Force Survey

-8 -6 -4 -2 0 2 4 6 8 10 12 14 1692

94

96

98

100

77Q4-83Q4 88Q2-94Q2 06Q2-11Q3

Index of employment, 100 = cyclical peak

Number of quarters from employment peak

Key conclusions

• Global and UK growth to pick up during 2012 after current weak patch

• Asia-Pacific region the key engine of global growth

• Growth recovery hinges on some resolution of current euro area crisis

• Global inflation to subside in 2012, but inflationary pressures likely to re-emerge as global economy picks up again

• UK inflation unlikely to fall as sharply as MPC expects, aggravating credibility issue