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Investment Research — General Market Conditions

Today’s release of retail sales in September was the last major data publication before

the first estimate of GDP growth in Q3 is out next week. Retail sales were strong in

September but only account for 5.7% of GDP. Based on the key economic figures for

Q3 released so far (we only have 44% of all information) we estimate GDP growth

slowed to 0.5% q/q in Q3 from 0.7% q/q in Q2. This is still at trend.

PMI services have declined fairly sharply during Q3, indicating slower growth in

services (78.4% of GDP). Still, we estimate growth in services increased to 0.7% q/q

in Q3 from 0.6% q/q in Q2 due to overhang from a large increase in June. This

corresponds to a GDP growth contribution of 0.6pp in Q3 up from 0.5pp in Q2.

Manufacturing production was weak in Q3 but this was offset by higher mining and

quarrying, implying that total production (14.6% of GDP) most likely neither

contributed positively nor negatively to GDP growth in Q3 (+0.1pp in Q2).

Construction data (6.4% of GDP) have also been weak and we estimate a negative

GDP growth contribution of 0.1pp (+0.1pp in Q2).

The UK was back in deflation in September, as the annual growth in CPI fell to -

0.1% y/y from 0.0% in August. The very low inflation is due to a combination of the

falls in oil and food prices and the strong GBP, which weighs on inflation through

lower import prices. Services inflation is the only component pulling inflation up at

the moment. Services inflation increased to 2.5% y/y in September, the highest since

October 2014, from 2.3% y/y in September. The annual growth rates in services

prices are somewhat volatile but the increase indicates that domestically-

generated prices are increasing. Although services inflation is above the BoE’s 2%

target, services inflation is still low from an historical perspective. We think CPI

inflation hit the bottom in September and that it could move slightly higher in

the coming months before picking up early next year when the base effects from the

fall in oil prices in H2 14 begin to drop out of the consumer price index.

Average weekly earnings excluding bonuses (3M avg.) slowed to 2.8% y/y in August

from 2.9% y/y in July. We think the slower wage growth is due more to the

volatility of the series than a sign of weakness in the labour market. Unemployment

rate (3M avg.) declined to 5.4% in August from 5.5% in July and is still around

NAIRU. Employment (and the employment rate) is record-high. Surveys indicate that

recruitment difficulties are very high. Thus we still see an underlying upward trend

in wage growth and think wage growth will accelerate going forward as the labour

market continues to tighten.

As the labour market continues to tighten and the underlying wage growth is

trending up, we think the case for a hike is building and thus we still expect the

BoE to hike in Q1 16, probably February. Consensus among analysts is still Q1 16,

although more analysts now expect the first hike in Q2 16. In our view, the risk is also

tilted towards a hike later in 2016, but the underlying positive trend in wage growth

will, in our view, put more pressure on the BoE to tighten than currently recognised.

Market pricing continues to be too dovish in our view.

22 October 2015

Analyst Mikael Olai Milhøj +45 45 12 76 07 milh@danskebank.dk

UK research

Slower wage growth not a sign of

weakness in the labour market, 14

October

Back to deflation – we think this is

the bottom for now, 13 October

Bank of England review: Slightly

dovish as inflation outlook is

lowered, 8 October

Pre-conditions for BoE raising rates

Source: Danske Bank Markets

UK macro monitor

Growth likely slowed in Q3 but still at trend

Condition Status

Unemployment < or = NAIRU √Wages > 2 % √Solid growth outlook (above or at trend 0.5% q/q) √CPI inflation moving higher xNo financial stress ?

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Business cycle indicators

PMI services suggest weaker growth in services Weak manufacturing production in Q3

Source: ONS and Markit Economics Source: ONS and Markit Economics

Growth in mining & quarrying offset falling manufacturing

production PMI construction to the weak side in Q3

Source: ONS Source: ONS

Consumer confidence at its highest level post-crisis Retail sales indicate growth in private consumption

Source: ONS Source: ONS

Economic activity

Economic upturn remains on track Growth mainly driven by services

Source: ONS Source: ONS

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UK GDP above pre-crisis level Only services GVA back above pre-crisis level

Source: ONS Source: ONS

No productivity growth Financial stress also hit UK equity market

Source: ONS, Danske Bank Source: FTSE, Stoxx, S&P

Monetary policy & inflation report

Bank rate still 0.50% - we expect first hike in Q1 16, possibly

in February

BoE’s CPI projection likely to be revised further down in next

inflation report

Source: Bank of England Source: ONS, Bank of England

Unemployment rate expected to crawl below NAIRU soon Economic upturn on track according to BoE

Source: ONS, Bank of England Source: ONS, Bank of England

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Inflation and wages

Both headline and core inflation very low Very low inflation due to fall in energy, food and import prices

Source: Office for National Statistics Source: Office for National Statistics

Low oil price weighs on inflation Also deflation in food prices

Source: Office for National Statistics Source: Office for National Statistics

Wage growth is picking up High real wage growth due to combination of very low inflation

and increasing nominal wage growth

Source: Office for National Statistics Source: Office for National Statistics

Labour market

Unemployment more or less ‘normal’ Declining slack has led to higher wage growth

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

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Unemployment is falling again following a small increase in

Q2 Improvement in the labour market has eased off

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

Housing market

House price increases have slowed RICS survey indicates pickup in prices

Source: ONS Source: ONS, Nationwide, Halifax and RICS

Record-low mortgage rates support the housing market Housing market activity has picked up slightly

Source: Bank of England Source: Bank of England and HM Revenue and Customs

Foreign trade

Continuous trade deficit Positive trade balance in services

Source: ONS Source: ONS

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GBP appreciation against EUR driven by divergent monetary

policies

Larger current account deficit in recent years due to lower

primary income, not larger trade deficit

Source: Bank of England, Danske Bank Markets Source: ONS

Public finances

Fiscal consolidation at slower pace in coming years than

previously indicated Gov. deficit most likely higher this year than anticipated

Source: ONS, OBR Note: The financial year runs from April to March. ‘1’ refers to April, ‘2’ to May

and so forth.

Source: ONS, OBR

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Disclosure This research report has been prepared by Danske Bank Markets, a division of Danske Bank A/S (‘Danske

Bank’). The author of this research report is Mikael Olai Milhøj, Analyst.

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